Saturday Review For Jan 22, 2022

“The longest four day week ever” is something I overheard late Friday on one of the business networks. I think most of us can agree that is a perfect short summation of last week’s market action. Those of us that are close to the markets see things before the general public, so I do not think the market action last week is too surprising to many professionals. However, average folks are now showing some concern and the google search figure last week for “Stock Market Correction” is on track to hit the maximum reading of 100 (chart below).

Generally, this search term is a contrary indicator as the impression is average investors only get worried about the stock market when it has already lost value. However, the other two instances where the reading hit 100 during what I am calling the Pandemic Era proceeded very different results. The table below shows S&P 500 (SPX) performance up to 4 weeks following a spike in searches about a market correction.

The only thing the other two observations have in common is a slightly bullish first week. After that the 2020 occurrence is followed by a market correction while last year’s observation was near a market bottom.

The SPX lost over 5% last week. This gives it default ‘winner’ status as the Russell 2000 (RUT) and Nasdaq-100 (NDX) fared much worse. Each volatility index rallied with the Nasdaq Volatility Index (VOLQ) rising ‘only’ 8.48 points, this may be a function of VOLQ already at slightly elevated levels in anticipation of earnings announcements from the larger NDX components coming up this week and next.

One trader timed things quite well with respect to the end of week sell off in NDX. The specific position used Micro Nasdaq-100 Index (XND) options. Late Wednesday, with XND around 151.90 a trader came in with a big sale of the XND Feb 18^th 162 Calls. In seventeen different transactions, a trader sold 544 of these calls at an average price of about 0.56. As a quick reminder, XND is 1/100^th the size of NDX so this is a trade expecting NDX under 16200 or XND under 162.00 at Feb 18 expiration. The chart below shows the time when this trade was executed highlighting some great timing behind the trade.

 

Traders looking for flexibility are also turning to the smaller sized index option markets like the Mini-Russell 2000 Index (MRUT). MRUT is 1/10^th the size of the Russell 2000. On Wednesday MRUT was at 210.12 when a trader came in putting on a 1×2 using MRUT Puts expiring on Feb 18. Specifically they sold 5 MRUT Feb 18^th 212.50 Puts for 7.83 while also purchasing 10 of the MRUT Feb 18^th 220.00 Puts for 12.41 each resulting in a cost of 16.99 per spread.  The result at Feb 18 expiration shows up below.

 

This trade breaks even very close to 210.50, just a tad above where MRUT was when the trade was executed. The worst-case scenario result involves an MRUT rally to 220 or higher by February expiration. At that level all options expire out of the money and the trade loss is 16.99.

January VIX futures expired last week handing the front month baton to February.  The curve is as flat as I can recall, especially with VIX in the upper 20’s. My experience is that a flat VIX curve indicates uncertainty and I think that reflects how many market participants feel these days.

 

 

The VIX indices also all moved higher last week. The 6-month version is the peak of the various indicators or expected volatility. This coincides with market participants thinking the first half of 2022 is going to be a tough ride, but we should be back on course at the end of the year.

 

In the VIX arena an interesting spread selling 8 different Feb VIX options hit the tape on Wednesday (shout out to Mark Sebastian for pointing this out). The trader sold 4 out of the money puts and 4 out of the money calls taking in a net credit of 12.20 per spread. The specific options and execution prices appear in the table below.

The result is a deviation of a short strangle that makes a maximum profit if February VIX settlement falls between 22.00 and 26.00. Partial profits can be realized if VIX is over 17.20 or below 33.60 and the trade held to expiration.