We are coming toward the end of the second quarter reporting period, but still have several names to go. As always the histories below represent three years with the exception of those in italics.
In a recent news article in Bloomberg, Callie Bost noted this year’s relatively strong performance for the CBOE S&P 500 BuyWrite Index (BXM), and she wrote —
“Traders Score With Buy-Write Options Strategy Tuned to U.S. Calm. Traders selling calls on stock holdings are beating the S&P 500 for the first time since 2011. The torpor in U.S. equities is proving a bonanza for traders employing an options tactic designed to capitalize on dead markets. … ‘A churning market is the buy-write index’s best friend,’ said Mark Sebastian … ‘The fundamental drivers of buy-write’s underperformance – – Federal Reserve bond-buying and zero interest rate policies -– is coming to an end,’ Nicholas Colas, chief market strategist at Convergex Group LLC, wrote in a note Tuesday. … “
Ms. Bost also noted that the shares outstanding in an ETF designed to track the CBOE BXM Index rose to a record high in May.
CHARTS SHOW STRONG Y-T-D PERFORMANCE FOR BENCHMARKS THAT SELL STOCK INDEX OPTIONS OR VIX FUTURES
Below are three charts showing the year-to-date % changes through July 29 for select total return benchmark indexes. (Total return indexes are pre-tax indexes that take into account reinvested dividends, which can have a significant impact over longer time periods.)
Note that all five of the buywrite indexes in Exhibit 1 had higher returns year-to-date than the four “traditional” indexes in Exhibit 2, and that two of the indexes in Exhibit 2 were down so far this year. Buywrite strategies harvest options premiums and often have the goal of generating returns that are smoother and more consistent than returns of equities and commodities.
Exhibit 1 More
Editor’s note: We would like to welcome Park Research LLC @ParkResearch to the CBOE Options Hub family with their look at EA earnings in front of their report after the close today.
Electronic Arts will have their earnings released after Thursday’s closing. While we tend to think of an earnings release as a binary event – and more than not it is – we can also use the historical information to assess how investors and traders tend to react to the news.
Let’s take a look at some information. As of Wednesday (July 29), $EA closed at 72.18. Naturally, we looked at the 72 straddle. The options were marked at $4.90 or 7.11% move – this move is calculated from 72.18 to break-even to the downside of 67.05. As you can see below, that straddle move is described as the light blue filled area. Each candlestick is from each earnings move with 1 being the most recent to 20 being prior 20Q earnings move (i.e. 5 years ago).
Out of the last 20 earnings, at least 11 of them had moved greater than the above straddle price some time during the day, but more importantly, 15 of them closed higher than the previous close and 17 of them were trading higher some time during the day. On average, its absolute max move for 20Q was 9.68%, its absolute gap open move was 5.06%, and its absolute closing move was 7.36%. On average, its max move is 10.99% and its close is 8.49% when the stock closed higher than the previous close. In this case, we want to take a look at a synthetic long, selling $68.00 puts and buying $77.00 calls with $0.06 credit. The breakeven area is $67.94 (ex. Commission); slightly above the lowest close area of $67.71 or -6.195%. However, on average, we expect the stock to be around $77.49 (using the average of absolute closing of 7.36%) well above $76.94 breakeven area or possibly to $80.11 (using the average of up closing of 10.99%).
Will history repeat itself? We can’t be sure, but it seems the potential max risk is $0.23 while the potential reward is from $0.55 to $3.17. In the end, if you want to make money, you have to play the game…. And, as they say, “EA Sports, It’s In the Game”.
The collar can be expanded to create a truly creative variety. The traditional collar (own 100 shares, sell 1 covered call, and buy 1 put) can be turned into a long-term protective version:
- buy 100 shares
- sell one very short-term covered call, maximizing annualized income as the result of time decay, picking a strike higher than the cost of your stock
- buy one long-term put (8-10 months)
This accomplishes a relatively high rate of return without the need to replace the put. The short call expires or is closed and then replaced as many times as possible. This should more than pay for the relatively rich long put, but on the installment plan. A one-month call could be opened and expired up to 8-10 times over 8-10 months.
Meanwhile, you get the insurance protection against downside risk. If the stock price falls so that the long put goes in the money, its value increases one dollar for each point lost in the stock, limiting downside risk.
Because the put is paid for on the installment plan, it doesn’t really matter how time decay happens. The net outcome is a wash between long put and short call. This is a no-cost or low-cost way to get the insurance put but without having to turn over the collar frequently.
Ideally, you get the downside protection, and over time the short call premium and dividends more than pay for the put. More
Today CBOE announced in a press release that it has created 10 new options-based strategy performance benchmark indexes that are designed to highlight the long-term utility of options as risk management and yield- enhancing investment tools. CBOE will disseminate intra-day values for the new benchmarks beginning August 3, 2015 at the page www.cboe.com/benchmarks. The new benchmark indexes use popular S&P 500® Index (SPX) Weeklys options to create new versions of two of CBOE’s flagship strategy benchmark indexes — the CBOE S&P 500 BuyWrite Index (BXM) and the CBOE S&P 500 PutWrite (PUT) Index — as well as completely new risk-managed option selling strategies featuring S&P 500 Index (SPX) and CBOE Volatility Index® (VIX® Index) options.
CHART SHOWING LESS VOLATILITY
Six of the ten new indexes (as well as CBOE’s BXM, PUT and CLL indexes) have data history going back more than 29 years, to June 30, 1986.
While there still are some investors who think that all options strategies are inherently volatile and risky, a very striking fact is shown in Exhibit 1 below – all nine of the options-based benchmark indexes in the Exhibit had less volatility over the 29-year time period than the three “traditional” indexes – the S&P 500®, MSCI EAFE®, and S&P GSCI indexes.
DESCRIPTION OF TEN NEW BENCHMARK INDEXES
A description of each index follows: More
Editor’s note: We would like to welcome Park Research LLC @ParkResearch to the CBOE Options Hub family with their look at DECK in front of tomorrow’s earnings report.
Now just about every trader knows that both $GOOGL and $NFLX blew out of the water. So, which earnings trade has potential like that this week? Most traders might guess that $AAPL or $AMZN might be just that stock. And that’s very possible. However, I believe that this other stock has potential to blow premium sellers more than any other stock: $DECK.
Let’s take a look at some information. As of Friday (July 17), $DECK closed at 72.16. Naturally, I looked at the 72 straddle. The last they traded was at $2.38 or 3.60% move – this move is calculated from 72.16 to break-even to the downside of 69.56. As you can see below (figure 1), that straddle move is described as the light blue filled area. Each candlestick is from each earnings move with 1 being the most recent to 20 being prior 20Qs earnings move (i.e. 5 years ago).
Out of the last 20 earnings, at least 19 of them had moved greater than the above straddle price some time during the day. Out of the last 12 earnings, 11 moved in such a way. On average, its absolute max move for 20Qs was 12.02%, its absolute gap open move was 8.20%, and its absolute closing move was 10.47%. Unlike $NFLX, its lowest closing move was 0.7% only 4Q 2014. Therefore, there is a chance that I could lose a lot, but I also stand to gain 190% (10.47%/3.60%) on average closing. It’s a good risk/reward ratio.
I use the Kelly Criterion to make my trade decision in the end and it gave me 86.96% leverage calculation using the closing average of the 20Q historical information. Does it mean I will have 100% guarantee? No, but I sure like my chance of buying the premium. ATTENTION ON DECK! Earnings Reports!
*On the side note, I use 1/25 to 1/50 fractional Kelly Criterion for earnings trade since there are still lots of uncertainty involved. In addition, I use the option level 3 (naked margin requirement) for determine the leverage scheme, not portfolio margin to ensure that I don’t overleverage the account.
When a trader is making a trade based upon an upcoming earnings report the first thing that they will look at is the at the money (ATM) straddle in the expiration cycle that is closest to expiration. The earnings report for Facebook (FB) is being released this afternoon on July 29th at 4:00 pm ET, immediately after the close. There are weekly options that expire two days later on July 31st. With FB trading at 95.50 let’s take a look at the FB Jul 31st 95.5 calls and puts. The market for the calls is 3.80-3.90 and the put market is 3.80-3.90. The straddle market is 7.60-7.80. The market is implying that FB will be trading between 87.80 and 103.20 over the next two days. The implied volatility (IVOL) for the straddle is 121.57%. At the most basic level when a trader believes that the range will be narrower then they will sell the straddle and if they believe that FB will trade outside of that range then they will buy the straddle.
Short Straddle More
When writing covered calls, it’s important to accurately compare one expiration to another, to make certain that your analysis is accurate based on both rate and time. You can compare annualized returns under the following guidelines:
- Make all yield comparisons to the strike. Use the strike for consistency, based on the rationale that if exercised, the strike will be the price at which you sell shares. Alternatives are to base the analysis on your stock basis or current price, but both of these vary and will distort the results. Using the option’s strike makes the most sense.
- Compute the initial yield on a covered call. Divide the premium by the strike. Do this for a range of calls you are considering. If the premium is 3.50 and the strike is 70, the initial yield is 0.05, or 5%.
- Divide the yield by the holding period. For example, if two months remain until expiration, divide the yield by 2. If three weeks remain, divide by 0.75 (three-fourths of one month). Or use actual days; divide the return by days between now and expiration. For example, if the expiration is exactly 3 months away, divide 0.05 by 3 and multiply by 12: 0.05 / 3 x 12 = 20.0%. Or if the remaining days are 92: 0.05 / 92 x 365 = 19.8%.
Though we had four down sessions this past week and drop of 2% for the SPX 500, the action had a more normal feel to it. What am I talking about? First and foremost, it was nice for a change the market sentiment was not being driven by Greece. Since mid-June that has been the case, the unpredictability over a resolution has gripped investors/traders in a panic. When payment deadlines for Greece passed it was all but assumed the worst would happen and volatility shot through the roof in a short period of time.
And then there is China, with their very sudden bear market (20% down or more) and their government’s attempt to arrest the selling. Their policy methods intervention, coercion and force are unconventional at best but seemed to work in the meantime. Their issues are complicated and far from resolved.
Finally, we saw the markets reacting to ‘normal’ stuff – the economy, worries about interest rates, fed policy changes, demand/supply for commodities and currency concerns. Not that these are easy issues to resolve, but when you’re not listening to political rhetoric from a nearly bankrupt country it makes the analysis less complicated.
But this past week had earnings season back on the radar, and given the lousy growth in the economy we were due to see some mixed results. So far this has been a case of the ‘haves vs the have nots’, but that has been a theme for the last few quarters. Commodity names are struggling, first seen by the results of Alcoa, which reported mixed earnings, weak guidance and the stock has dropped about 10% since.
As for the indicators, we had been warning a potential drop was due, and that happened. The SPX 500 fell 2%, the Dow Industrials off 2.77% and the Russell 2K down even more, off 3.12%. What did we see last week that foresaw a drop? The market was overbought on several measure and some pressure needed to be relieved, but these steep drops tend to get everyone overly concerned. While the drop was sharp we are not seeing encouraging signs the market may now turn HIGHER.
Let’s start with the VIX, it reached under 12% again last week, which has often been a danger sign. It doesn’t mean stocks cannot move higher, but that level has been marked as a point where markets lose altitude – if just temporarily. On cue, Tuesday started the decline and market could not recover the rest of the week. The VIX climbed but ‘only’ made it back to 13.74%. Further, the spot VIX separated from the futures on Wednesday when the July future expired, and that needed to be corrected. See the chart here from Jay Wolberg of www.tradingvolatility.net.
Using options to focus more on either uptrend or downtrend is an effective method for augmenting the swing itself. The strategy assumes that you have an opinion about the prevailing direction of movement in the underlying, and that momentum confirms your opinion. So as a starting point, you can coordinate a weighting decision by checking some of the best momentum oscillators like RSI or MACD.
There are numerous methods for weighting one side or the other. On the bottom of the swing, bullish weighting can include:
- Increasing the number of long calls opened (for example, opening two long calls will create twice the profit of upward movement in the underlying when in the money; and of course, three calls will triple the effect).
- Increasing the number of short puts opened (this does the same on the downside, and weighting long puts accelerates out-of-the-money profits as long as the underlying price continues to rise).
- Combining long calls with short puts, creating a synthetic long stock position (the synthetic is low-cost or no-cost because the long premium is paid for by the short premium, and yet the overall position reflects price movement in the underlying point for point in the money).
- Increasing the number of long puts opened (as with the bullish side, this bearish approach creates ITM profits from the puts at a rate greater than movement in the underlying).
- Increasing the number of short calls opened (this is a higher-risk strategy in the event that the underlying price rises; but if your indicators say the price will move south, this approach increases current income and cushions the risk, leading to profitable “buy to close” orders).
- Combining long puts with short calls, creating a synthetic short stock position (the risk is greater due to the short call, but also consider making this into a collar by holding shares of the underlying).
All positions including uncovered short options also require collateral to be kept on deposit. Before embarking on any positions with uncovered options, check the collateral rules with the free download at CBOE Margin Manual
The weighting concept can be expanded and made more conservative by also holding stock when short calls are employed. However, even a covered call can be effectively weighted with the use of a ratio write. Even better, a variable ratio write expands income without adding significantly to risk, since higher strikes can be closed, covered or rolled before the position move in the money. Another form of weighting involves backspreads, in which “cover” of short positions is accomplished by buying a larger number of higher-strike calls (or lower-strike puts).
Editors note – we would like to welcome Meredith Kelley Zidek as a new contributor to the CBOE Options Hub. Meredith is a private investor whose interests include equities, options, and commodities. She began trading equities in 2007, and since then has cultivated interests in corn, energy, and most recently, index and equity options. Almost all of her trading, which can be seen on grapestrades.blogspot.com, involves short options on volatility-related instruments. She studies the movements of world indexes and analyzes options chains to determine advantageous timing for short-selling of contracts. Meredith holds a B.A. from Loyola University, and resides in Hunt Valley, Maryland.
Sometimes it isn’t the biggest trade that brings the most joy. Very late Friday afternoon, a casual idea got real so quickly that I rushed to construct an order with only minutes until market close. Checking the time as I worked, there appeared to be mere seconds left, but I submitted it anyway. The result is a trade that turned into an instant money-maker that grew to all but 15% of its potential value less than one full trading day after the crazy wish-making order was incredibly filled.
So what do you think I did? Instead of waiting four more days to find out if the tide would turn against me and if the tide might contain sharks and jellyfish, I just cashed it right in today. Someone else took ten cents, and I thought I would probably not unload it for five, but in another wish-making fishing-line-throwing, I just cast my line to see if anything would bite.
Instant fill! No more worries about SVXY holding a knife to me up at the 98 level. I really, really, didn’t want to be responsible for selling someone $78,400 worth of that security. Wow, what a way to make $213! There has got to be an easier way. (Just kidding. I’d do that any day, a dozen times over, for $213 while I sit here and exchange bon mots with other traders on twitter.)
In my excitement, I neglected to thoroughly explain this: The opening order was time stamped received at 03:59:47 on Friday as pictured below, and I assumed it got swept away with the deadwood, but to my amazement, at 04:04:49, the order was filled and this short-lived but fun-filled adventure got started.
It’s the timing and the price on entry and exit that made this a fun one, not to mention the way I no longer have to think about SVXY cornering me into some social obligation I’m not prepared to fulfill. I really didn’t want to attend the 98-strike party and was looking for a way to gracefully decline just as soon as I accepted.
If $213 doesn’t thrill you – well, every trade cannot be a ball hit out of the park. Look back to some of my earlier posts in the month for more exciting fare – and I still have something in the works for this Friday.
Today the new nearby VIX® Weeklys futures (ticker “31VX/Q5,” with an August 5 expiration) rose about 7% and had a daily settlement value of 15.325.
Once the bearish ball got rolling last week, it got rolling in spades. In retrospect, however, the pullback makes sense in terms of when, where, and why. The S&P 500 (SPX) (SPY) as well as the NASDAQ Composite (COMP) both bumped into major technical ceilings, and right on cue, began a retreat that likely isn’t over yet.
We’ll dissect the breakdown below, as always. First though, we need to run down last week’s and this week’s key economic numbers.
Though a light week in terms of the total amount of economic data, last week was a huge week for real estate. We got a glimpse of new as well as existing home sales, in addition to the FHFA’s measure of home pricing.
Broadly speaking, the real estate picture continues to look good. Existing home sales soared to a multi-year high pace of 5.49 million in June, up 170,000 from May’s rate of 5.32 million. New home sales fell from a pace of 517,000 to 482,000 last month… a difference of 35,000. Though the data-breakdown doesn’t bode well for homebuilders, the trend in sum bodes well for real estate in general.
New and Existing Home Sales, FHFA House Price Index Chart
Source: Thomas Reuters More
The Weekly News Roundup is your weekly recap of CBOE features, options industry news and VIX and volatility-related articles from print, broadcast and online and social media outlets.
A 24/7 VIX?
VIX futures are available for trading nearly 24 hours a day….is it time for the VIX Index to be calculated around the clock?
“The Case for a 24-Hour VIX” – Steven M. Sears, Barron’s
VIX Futures Weeklys Are Here
The CBOE Futures Exchange (CFE) launched VIX futures weeklys contracts on July 23rd, arming investors with a dynamic new trading tool. Over 200 VIX futures weeklys contracts traded on day one and by noon today, volume had surpassed yesterday’s total.
“New Measure of Investor ‘Fear’ as CBOE Introduces Weekly VIX Products” – Saumya Vaishampayan, Wall Street Journal
“Making A Case For Even Shorter-Term VIX Futures” – Adam Warner, Schaeffer’s Investment Research
“Launch of Trading in VIX Weeklys Futures – More Expirations to Provide More Responsiveness” – Matt Moran, CBOE Options Hub
A TYVIX for Japan
S&P Dow Jones Indices and the Japan Exchange Group plan to introduce a new fixed income volatility index, the first of its kind in Japan. The new index, the S&P/JPX JGB VIX Index, will use the methodology of the CBOE Volatility Index (VIX Index) to measure the volatility of Japanese government bonds. The new index is similar to CBOE’s TYVIX Index which measures volatility in treasury bonds here in the U.S.
“S&P DJI and Japan Exchange to Launch First Fixed-Income Volatility Index in Japan” – The Asset
A shift in attention from macro events on the global stage to earnings reports here at home, has cooled volatility in the markets. Could this be a signal that the markets are going higher or just a pause in volatility?
“Record VIX Retreat Is Just Another Crash Scare Failing to Happen” – Callie Bost, Bloomberg
“VIX Collapses… Time Again to Buy VIX? – Chris Dieterich, — Barron’s
“This Indicator Suggests More Gains are ‘Very Likely’” – Stephanie Yang, CNBC
“The ‘Unusual Circumstance’ That Could Inspire Bulls” – Adam Warner, Schaeffer’s Investment Research
This week there was a pause in the “Euro ex-Greece” crisis and the plunge in Shanghai stock prices. In addition, Federal Reserve Chair Janet Yellen told Congress in her semi-annual testimony last week that the first Fed Fund target rate increase will come in 2015, and this week’s economic calendar was light.
No wonder there was a lull in volatility. TYVIX, CBOE’s real-time benchmark for Treasury volatility, decreased to 5.37 from 6.69 last Friday, which is below its median value to date, but still above its value a year ago. The VIX Index also edged lower, as did EUVIX, BPVIX and JYVIX.
How long will the lull last? In Treasuries, TYVIX futures predict lower volatility until the end of November. October VXTY futures are ending the week close to 5.675, compared to 6.875 on June 29, when the contract month was first listed, and 4.7 percent greater than TYVIX. VIX futures, on the other hand, are more bullish on volatility. At 11:10 a.m. ET, the price of October VIX futures was 16.7, or 21 percent greater than VIX. More