Sell the Index and Buy the Stock (Volatility)

(Editors note: Mark sent this to us Friday and due to a system issue we were unable to post it. The prices of the underlying stocks have changed but the concept is right on. Enjoy).

Goldman put out a comment prior to earnings season, which was something that I happened to agree with.  It basically pointed toward the fact that, while the VIX was overpriced relative to market movement, it didn’t mean the component parts IV’s were necessarily overpriced.  Their main point was that it might not make sense to sell premium in individual names; in fact, they might be a buy.  At the same time, SPX IV is probably still a sale.  Something that might confirm the low SPX expectations are the overall flat VIX curve and the low JCJ (CBOE Correlation Index).  Let’s quickly break down the trade

For starters, the VIX is a sale.  Take a look at how well you would have done selling premium in SPX since the 2nd day of the year. (image #1 below)

The JCJ is at post crisis lows (image #2 below)

Both of these graphs point towards the SPX not giving much of a hoot about earnings this cycle and probably not moving much.

Now let’s look at the straddles of some major names prior to their earnings:

Stock Implied Vol. Strike & Expiration Straddle Bid/Ask

GE 52.62 GE Jan 19 21.50 $0.52 – $0.57

INTC 82.50 INTC Jan 19 22.50 $0.66 – $0.88

GOOG 66.49 GOOG(W) Jan 25 700 $37.30 – $39.10

AAPL 108.40 AAPL(W) Jan 25 515 $36.60 – $37.55

NFLX 205.87 NFLX (W) Jan 25 105 $13.85 – $14.30

In the cases above, we can clearly see that the straddles were underpriced.  While I am sure there have been some stocks that have underperformed, I have not heard of many total duds.  I am on the other hand consistently seeing big names move hard on earnings.  So far, the trends are to buy stock straddles and sell SPX straddles.  I think those trends continue.

The Trade:

If a stock is being talked about a lot and the straddle seems expensive, it’s probably expensive for a reason.  I am not going short earnings straddles through this cycle.  Take a look at buying ‘hot straddles’ and shorting VIX or SPX straddles.attachments below from Livevol (r) www.livevol.com

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