Diamond in the Fluff (DIA)

by riskreversal December 20, 2016 2:08 pm • Trade Ideas

Doug Kass of Seabreeze Partners earlier issued a Tweet-memo to “talking heads”:

Yep It’s just a big round number, something for “talking heads” to focus on as they (we) run out of material following an epic 5 week rally that defied most conventional wisdom headed into the Nov 8th presidential election.

But the noise around the impending “milestone” might cause you to consider a few things. First and foremost if you own an index fund that tracks the Dow Jones Industrial Average (INDU), or the DIA, the etf that tracks the index, or some of the large components that have made up a chunk of the Index’s gains (Goldman Sach’s & JP Morgan account for 30% of the gains) then you might consider ways to book profits into what might be a very different volatility regime in the new year.

Second, f you are concerned with paying taxes in 2016 on big winners, as you think the 2017 tax rate will be lower, you are not alone which could create a situation where too many investors head for the door at the same time. So if taxes are not a concern you might consider a stock replacement strategy into the beginning of 2017 that lets you book some profits, stay in the game and define your near term risk.

The INDU is up 10% since Nov 7th and up 30% from its 2016 lows made in Jan.  To my eye on a the slightest shift in sentiment, a pullback in the DIA has the etf backs towards the breakout at $190ish:

DIA 1yr chart from Bloomberg

Short dated options prices in the DIA are very near 2016 lows, with 30 day at the money implied volatility at 10%, options prices for those looking to define their risk in a directional manner relatively cheap:


If you were inclined to play for higher highs, possibly taking profits in existing exposure, in the into January, but nervous about the potential for a sharp reversal, at the money DIA calls look cheap as chips.

For instance with the DIA at $199.50 you could the Buy Jan 20th (inauguration day) 200 call for $2.08 These calls break-even at $202.08, up 1.3% from current levels, while defining risk to just 1% of the etf price (below $200 lows full $2.08, lose up to $2.08 between $200 and $202.08).

That’s a fairly attractive risk reward, especially for those booking profits. On a rally one might look to spread these calls by selling a further out of the money call in Jan expiration.

Oh and for those who are less sanguine about the continuation of the rally in Jan, DIA put spreads look attractive, for instance, the Jan 200/190 put spread could be bought for about $2, offering profit potential of up to $8 between $198 and $190, while defining risk to just $2 or 1% of the etf price.

I would also add that looking at Spot VIX that tracks options prices on the S&P 500, we have seen vol spikes following unexpected geopolitical outcomes like China’s yuan deval in 2015, global growth scare following end of ZIRP in Q1 2016, Brexit, US election….now with rates higher and markets discounting uncertainty around new administration, seems ridiculous how risk is being priced into the new year. Are we nearing one of those events with the inauguration on Jan 20th where investors come to grips with the uncertainty the soon to be President of implementing economic and foreign policy via Twitter?