MorningWord: Summer Days, Driftin’ Away

by Dan August 26, 2016 11:17 am • FREE ACCESS

Dan is traveling today, and so is most of Wall Street it seems. Even the big news of the day comes from a Summer vacation location as Janet Yellen gave her highly anticipated speech in Jackson Hole. Peter Boockvar has some rapid response thoughts on the speech over at The Boock Report. And BK has some thoughts over at The Ticker District.

As far as how all this relates to options trading, it seems like it’s been forever since we’ve had any interesting volatility in the market and that seems to be related to a confluence of events turning the market into a non event at the moment. The Brexit vote earlier in the Summer scared a lot of longs and probably forced some bad sales at the lows. The quick turnaround in the markets since Brexit then shook out a bunch of shorts. As Peter mentioned we’re still in a holding pattern on what the Fed will do for the balance of the year, and we have the election in November hanging over everything and possibly keeping a lid on any quick moves by the Federal Reserve. Combine all of that with Summer vacations by much of the trading community and you have a VIX at 12.75:

Screen Shot 2016-08-26 at 8.50.22 AM
1 year VIX from LiveVol Pro

As we’ve mentioned in a bunch of posts over the past several weeks, this lack of volatility does provide a bit of an opportunity for positioning around specific dates. You may have noticed us mention the Sept2nd weekly expiration a few times as options that can probably be safely sold against low vol purchases in farther out months. Sept 2nd is the Friday of Labor Day weekend and is the last day we see this sort of skeleton crew at work on Wall Street trading desks.

The other date to keep in mind over the next month is the FOMC meeting on Sept 21-22. The fed fund futures still don’t expect a rate increase at that meeting. Dan has pointed to the election in early November as what will keep the FOMC from moving in the Sept meeting. But do keep an eye on the polls. If the polls keep pointing to a sizeable lead for Clinton it could take some pressure of the Fed and allow some flexibility before the election. I have no idea what that lead would have to look like but it is something to keep in mind. Currently, the RCP average of polls has Clinton over Trump by about 6% nationally. The electoral college math also shows a fairly predictable outcome at the moment. Obviously those polls could change (as we saw into Brexit), but as it is right now, if the election was today, there’d be little doubt about the outcome. (Sidenote: I’ve seen lots of references to Brexit as if the polls were somehow wrong. This is a misreading of the situation. The betting markets were very wrong and assumed something the polls did not. The polls into the UK vote showed a toss-up if not an outright lead for Leave. Those that thought the polls were wrong are the ones that lost money. The polls did change and went from Remain to Leave in the months leading up to the vote, but they weren’t “wrong”. If the vote was 2 months earlier there wouldn’t have been a Brexit, public opinion changed, and the polls reflected that.)

So as far as trading, I’ll just use one example because I got a question on it in our QnA section. It’s a question about a bullish call calendar in PG we highlighted into earnings:

Bullish: PG ($86.50) Buy the Aug5th weekly/ September 89/87.5 vertical calendar for 1.00

  • Sell 1 Aug5th weekly 89 call at .30
  • Buy 1 Sept 87.5 call for 1.30

The Aug5th weekly calls have obviously expired worthless, leaving a Sept 87.5 call for this idea. As I said, look to Sept 2nd on a trade like this to further finance. (this can be for any stock that doesn’t have an event next week). With PG 88.40, the Sept 87.5 calls are 1.55 vs. the 1.00 original cost basis. If I had this trade on I’d look to sell the Sept2nd 89 call at .27 and continue the vertical calendar positioning. This would reduce risk to .73 in the original trade with potential profit of .77 if the stock is at or above 89 on next Friday’s expiration. If the stock is below 89 that call sale will expire worthless and can be rolled out into Sept regular expiration for even greater profit potential.

The other possibility on this trade is to turn it into a vertical by selling an upside call in Sept regular like the 98.5 at .50. That would leave a $2 wide for 50c a risk with potential up to 1.50 in profits. It also expires before the Sept FOMC meeting, the other date to keep in mind.