Saturday Review For June 11, 2022

Early last week I had more than one market participant note that it was starting to feel like a typical low volatility summer season was commencing. I forgot to check in with those folks on Friday to see if they still felt like it would be a quiet three months. After Friday it certainly appears the market is not done with large daily price swings. All the major indices lost between 4% and 6% with the Russell 2000 holding up a bit better than the S&P 500 and Nasdaq-100.

The only positive I can see on the table above is VIX remaining below 30.00 despite a rough week for stocks. As long as these types of divergences hold up such as VIX remaining in the 20’s when the S&P 500 loses 5% in a week, I’m going assume there is limited downside remaining for stocks.

The VIX related ETPs did exactly what would be expected with market weakness as the long funds were all higher and the two short funds lost ground.

Finally, the VIX curve moved higher in a surprisingly uniform manner remaining in contango, at least going out to October.

VIX remaining in contango is another “we don’t seem to be panicking” indication for the markets. Honestly, I was not watching the markets too closely Friday afternoon and was prepared to write about VIX moving into backwardation before I saw the final numbers.

On Monday, with VIX around 24.95 and the July future at 26.85 one trader initiated a risk reversal by selling the VIX Jul 25 Put for 1.98 and buying the VIX Jul 35 Put for 1.52 taking in a net credit of 0.46. The payoff at July expiration appears below.

This is the sort of trade that should be monetized in the event of a quick move higher in VIX and the July future.  If VIX does not offer a nice exit opportunity, but it appears the put side of the spread will expire out of the money then the trade may be held to expiration. After a week where VIX mostly worked lower, this trade looked pretty solid on Friday with an unrealized profit of 1.11 based on the 25 strike put offer price of 1.25 and the 35 strike call bid price of 1.90.

A much shorter-term outlook was traded on Friday using options that expired that afternoon. We have discussed the increase in vertical spreads using NDX option expiring in a day or two. On Friday, one trader used the XND version of NDX. XND is 1/100^th the size of NDX so when NDX is quoted at 11900, the XND quote would be 119.00.

Just over an hour into Friday’s trading day XND was at 119.64 when a trader sold 100 XND Jun 10 119 Calls for 0.70 and purchased 100 XND Jun 10 117 Calls for 2.60 resulting in a net cost of 1.90 and a break-even on the close price of 118.90. The risk reward on this trade is poor with a potential gain of 0.10 or a loss of 1.90, if XND closed at 117.00 or lower.

I often get questions about these short-term option trades regarding how traders handle them if it appears the trade is not going their way. The chart below shows this trade was a tough one to stick with over the course of Friday’s price action.

Note about 30 minutes before the end of the trade day, when XND had moved up a bit, the trade was closed out. This occurred with XND at 118.93 with the XND Jun 10 117 Call sold for 2.06 and the short XND Jun 10 119 Call covered at 0.66 for a debit of 1.40. The result was a loss of 0.50, slightly better than a 0.57 loss that would have been realized if the trade was held to expiration.