Yesterday, an options trade in the XLF caught my eye. When the S&P Select Financial etf was trading $23.19 a trader paid .25 for 25,000 of the Oct 24 calls. Most of these looked to be opening (vs existing open interest) and with a break-even at $24.25 or about 4.5% higher than current levels. While 4.5% doesn’t seem like a whole heck of a lot, a look at the year to date charts shows the etf spending the better part of the year in a 5% range between $24 and $25:
The massive breakdown from above $25 in mid August to an intra-day low below $19 on August 24th dramatically increased the volatility bands in a risk asset that, until very recently, was anything but volatile.
The five year chart of the XLF shows the 45 degree ascent of the stock from the lows of the European Sovereign debt crisis in 2011. That steady march resulted in 100% gains until the late August swoon. It looked like easy money:
About those volatility bands. The five year chart of 30 day at the money implied volatility has come in about 30% from its recent highs, but it’s important to go back and see the highs from 2011, and how vol stay elevated for the first half of 2012. This is important because the two main headwinds to global growth at the moment (the health of China’s economy and the crash in commodity prices) have the potential to cause credit crises that can spill over to our banks.
So what looks like expensive vol has the strong possibility to be cheap under a handful of potential outcomes in the near term.
For the trader that is looking for a break above the recent breakdown level at $24, October is an interesting long vol choice as 40% of the weight of the XLF (BAC, C, GS, JPM, MS, USB, WFC) all report Q3 earnings that week.
I suspect $24 will be fairly staunch technical support in the near term and it will take a major cooling in China and some very solid results across the board for banks for the etf to get back within the prior range of $24 to $25.