EQD Research

Saturday Review For Feb 12, 2022

Feb 12, 2022

By Russell Rhoads,
head of research

This week’s chart of the week was an easy choice. The odds of a rate hike at the March Fed meeting have indicated for some time that we were going to get the first hike since December 2018. However, the consensus pointed to a 25 basis point hike. This past week, in reaction to comments out of James Bullard the President of the Federal Reserve Bank of St. Louis, that projection quickly shifted to a 50 basis point hike. The chart below shows the odds of a 50 basis point hike at the March meeting going back to early November and covering three months.

Data Source: CME Group

His specific comments called for a full 1 percent or 100 basis point hike by the July meeting. Before he spoke the odds of a 50 basis point move was increasing, but it really took off to the upside on the heels of his call for higher rates. The S&P 500 reacted with somewhat of an orderly move lower over the balance of the week.

Data Source: Barchart.com

As would be expected, VIX reacted to the anticipation of higher rates sooner with a move to the upside. The result was for only the fourth time on record the VIX high for the week surpassing 30 on the upside and the low for the week falling below 20.

Data Source: Barchart.com

My expectation was that the other instances occurred as VIX was on the way down, but that was the case in only one of the four cases. The other three occurred with VIX starting the week well below 30. Those three instances were last week and the weeks ending February 9, 2018 and May 7, 2010. Over the following three months, after the February 2018 instance, rebounded nicely and volatility subsided. For the same period following the May 2010 observation, the market experienced higher than normal realized volatility and stocks were lower.

For the week, the Russell 2000 was a winner, actually rising 1.39% while both SPX and the Nasdaq-100 (NDX) lost value. All three volatility indices rose in reaction to the increased uncertainty the market digested toward the end of the week.

Data Source: Barchart.com

The various VIX indices all moved higher in a parallel fashion. This contrasts with other recent increases where the shorter end of the curve moved to levels higher than the longer dated indices.

Data Source: LiveVol

The futures term structured finished the week with spot VIX and all active futures closing with in a very narrow range.

Data Source: LiveVol

I’ve always equated a flat curve with uncertainty as futures traders contemplate the next move from volatility. I think the picture above reflects a lot of wait and see among market participants.

A couple of late Friday trades in the VIX complex appear to be looking for volatility expectation to rise over the next few months.  First, there was a buyer of the VIX Jun 25 Calls for 5.76 who then sold the VIX Jun 30 Calls at 4.40 for a net cost of 1.36. That payoff at expiration shows up below.

The second trade looks to March expiration, which will be the front month after this week. This trade purchased the VIX Mar 20 Calls and sold the VIX Mar 35 Calls for a net cost of 5.40.

This second trade is a great example of using a vertical spread instead of trading futures and using targets and stop loss orders. I have always preferred the defined outcomes that options give you versus futures, especially in a market like VIX where things move real fast.

As noted above, NDX had a tough week, losing 3%. This places NDX down over 12% for 2022. VOLQ’s surge over 30.00 last week is a direct result of the tough week for NDX. Traditionally, VOLQ is at it’s lowest point relative to VIX during February and March.  So far in February this pattern is not repeating itself.

Elevated volatility creates opportunities for traders who like to implement strategies based on volatility subsiding to lower levels. Pros like the iron butterfly and one caught my eye late Friday.  With NDX at 14280 a trader sold the NDX Apr 14th 14750 Call for 440.30 and the 14750 Put for 920.89. They completed the iron butterfly by purchasing the 14250 Put for 692.02 and 15250 Call for 238.65. The net result of all these legs is a credit of 430.52.

Do note this trade is slightly bullish in nature. My assumption is this trade will not be held to expiration. The probable intent is to exit the trade if NDX is close to 14750, volatility has dropped, and the magic of time decay has resulted in a profit taking opportunity.

Finally, the in the RUT arena, the last sizable trade of the day hit the tape during the final half hour of the week with RUT at 2031. The other trades I’ve showed today have a longer term outlook than many option trades, but that’s not the case for this RUT trade. A trader sold the RUT Feb 14th 2090 Calls for 2.70 and purchased the RUT Feb 14th 2095 Calls for 2.20. The payoff on Monday’s close shows up below.

Barring a 2.9% rally in RUT, this trade safely keeps the 0.50 premium received from selling the spread. Although things are uncertain these days, that would be quite the move. Especially, with talk of a substantial rate hike coming next month.