Master of the House

So when a stock sees some options pumpage, time to go a Buy-Writin’. Right?

Not really.

The other day MA options were hot ahead of the earnings. Roger caught some guy on TV recommending a purchase of stock around 255 vs. shorting the Aug 270 calls around $12. Why? The stock was going to lift after the blowout earnings, and the calls were fat.

MA is near 230 now, clearly not the best idea from any standpoint. And not just because it didn’t work out. Gaming the direction of an earnings reaction has extremely little edge. And those options premiums were high for a reason; earnings were due.

Roger added this.

That the stock so quickly moved beyond the amount of the fat premium as I suggested as being possible does not represent any sort of knowledge about the stock or its earnings but very simply this is a frequent occurrence in these sorts of situations. It will repeat many times over.

Buying a stock because it has a lotta option juice is probably the wrong way to come at this. If a stock you like has a lot of juice and you want to take advantage of that, ok, you are coming at it from owning the stock and selling an occasional option as opposed to saying to yourself ok, where can I find some juice.

Yes, zactly. The point being that hunting down fat premium to sell and stumbling on the MA’s of the world is a recipe for disaster. Particular ahead of earnings. Of course you’ll see fat options, they’re always fat at that time.

If you happen to own MA and want to write a couple calls, maybe that makes a little more sense. But I would suggest there are no favorable odds in that either. It is still correct to look at the call sale in isolation. You’re already bullish on the stock, based on the fact that you actually own it. There’s just as much chance that you give away nice upside with the call sale in return for saving a few bucks on the downside. That’s a zero sum expected gain over the course of time. More often than not your position will “work”, i.e. the volatility will come in and the stock won’t move much and you’ll be happy you did it. But that will be offset by the occasional disaster where the stock gets plowed and the call premium barely eats into it, or the stock explodes and you kick yourself for the upside you left on the table.

The only sure way to call a bottom is of course to………keep calling one. Does it actually make anyone money bringing on Bobblehead after Bobblehead to opine on it? 

Harry Schiller expresses my sentiments exactly over on RM the other day.

All morning I am hearing people proclaim that the bottom is in. So what? The Dow is now over 700 points off the lows. The financials have rallied almost 40% off the lows and even now are about 30% off the lows. So you’re thinking about buying the financials now? Great plan.

Personally, I would rather not worry about such arcane and ultimately unknowable things and concentrate on buying the next hard break for the next inevitable rally. That’s all I want to do. I have no interest in trying to determine if another shoe is yet to fall. How many more skeletons are in the closet, etc., etc., etc.

I realize I am a volatility trader, and short-term oriented, so “bottom” is a pretty useless concept, other than the fact it’s some sort of support to lean against if it gets anywhere near there again. But no matter what your time frame, does it matter in the least? Particularly so many points after the fact. I doubt all that many investors did nothing, nothing, nothing and then got 100% long right then and there.

More reason why this whole exercise is kind of pointless? How about the fact that what we’ve seen in Financials is beyond classic Bear Market behavior. This from Bespoke.

With the sector down over 25% so far this year, it’s hard to believe that the Financial sector has had most of its best one-day performances since 1990 during 2008. But as shown in the chart below (click thru to see) , seven of the ten best days for the sector (red dots) have come during 2008.

If this story sounds familiar, it’s because we experienced a similar situation eight years ago with the Tech sector. As shown below (again, click thru) , the Technology sector had nine of its ten best one-day gains during the bear market of 2000-2002. There’s a reason they say big days come in bad markets. When the dust settled in tech stocks, they had lost 82% of their value over a stretch of 132 weeks.

As Bespoke notes, financials never lifted as euphorically as tech, so not likely you see that 82% drop. But whatever. Yada yada yada, by all means, try to ride these turns for a short term trade. But don’t try to call some longer term bottom, it’s useless.

Right here right now, I’m net long financial and energy gamma vs. short index gamma, sort of Dispersion Light. I basically fade moves in both financial and energy and play defense in the indices if need be.

OK, here’s a vaguelly interesting comparison.

On bottom we have the 10 day historical volatility of the SPY. It is a noise-filled reading designed to capture the volatility feel of the market.

Up top we have the VIX, the option guestimation of volatility going ahead 30 days. Obviously you can have divergence, as one looks backwards and the other forwards. But clearly there is quite a bit of correlation. And that makes sense, as you project the volatility you feel now when you decide how much to pay for options that go forward.

So what’s vaguelly interesting? Well look now. On the top graph you can see actual market volatility creeping up ever higher. Yet options don’t actually believe it. Nice pop yesterday, but in general it has a bit more work to do to even get up to where the market is trading. Much less go higher and show some sign of actual Fear.

So as briefing noted, some nice volatility poppage in GDX yesterday. AEM here is one of the more volatile decent-size miners, and we’re seeing options right around 52 week highs. With the stock on the very broken down side.

Keep in mind also this is only a few days past earnings, so no real news expected, it’s just ugliness.

On the one hand, I’m not averse to owning gamma when volatility breaks out and the stock is hitting new levels. On the other hand, I like that sort of play better in an “up” name. I am long gamma small here now, but not real thrilled with the position and would sooner bag out than add on more.

So how about we revisit the “SKF=Fear Index” notion now that America’s Most Insane Inverse Product is on the move again.

The chart here measures 10 Day historical volatility of SKF stock itself. Most historical volatility charts cover 30 days, the same timeframe the VIX seeks to express, and thus the historical chart tends to lag action in the here and now. A 10 day chart clearly has more noise, but also rings closer to how the stock feels.

And this one clearly feels pretty wild.

Now it’s going to compress a little bit, as data from the crazy ranged expiration week moves out of the system. But by the same token, the trend of the last couple days is towards big ranges again.

Bottom line is that once again, the relatively tame VIX on the screen fails to capture the generational fluctuations going on not much below the surface.

The  most common question I get here,? “Who is that French anchorwoman”. The 2nd most? “Why didn’t my puts move up when the stock opened down 3 points,  and are the MM’s rigging the quotes?

Along those lines, Mark from Options for Rookies forwards me this  piece he wrote a few years ago in SFO Magazine.

“I don’t understand what happened. Yesterday I bought puts. The company announced disappointing quarterly earnings, the stock dropped from 104 to 100, and I’m losing money. How can this happen? Help!”

This lament from an inexperienced options trader recently was posted on a message board that I frequent. It reaffirms my belief that too many people jump into trading without fully understanding how options work. The purpose of this article is to answer the question raised by the person that posted this frustrated message and to ensure that SFO readers understand that it takes more than just an opinion about which way a stock is going to move before buying options.

Yes yes and yes. Traders need to always remember that option prices have two components.

One is the directional bet, the other is the volatility bet. You can easily win a directional bet, and lose a volatility one, and get slammed.

We all know about earnings bidups, but there are just general bidups and selloffs in volatility too. One day we’re obsessed with every financial going to 0 and options are exploding, the next day, The Worst Is Over and you can’t sell a thing. A few days in, you may have seen the market lift, but volatility get smacked so much that call options actually went down.

It’s important to note that just like stocks, options are auction markets. There is no “set” volatility, it’s the market pricing in Fear and Time. And as that Fear dissipates, traders start worrying about time again, namely time eroding the value of their options in the absence of much movement in the market. And they lower their bids and offers.

OF course it’s possible to mitigate volatility risk, and make pure directional bets. A vertical spread, buying one option and shorting one in the same expiration cycle, but different strike, is an ideal directional play with very little volatility risk. You give up your “windfall” chance, but also take on small risk if you are wrong in every which way.