An Options Play on Uncertainty

03/04/2013 8:00 am EST

Focus: OPTIONS

The market hates uncertainty, notes Andrew Giovinazzi of OptionPit.com, and he offers a trade idea for when things calm down again.

As I write that little gem, it was one of the first things I learned as a market maker. To be more specific what I learned and what I taught was as a market maker was that you make the paper pay for your uncertainty. If the tape is starting to go to a place you are unsure of, raise the volatility. That is a mantra I always go with. The “tape” is the price and volume action in any particular time period. While we don’t do a technical analysis, per se, we do look at a chart and those charts are volatility charts in conjunction with the normal price and volume charts. Sometimes just a cursory look at the tape is instructive.

On the close Thursday, the market had a pretty decent reversal. I was looking at cutting down some deltas on an iron condor in the Gold Course trading lab and all the while the market kept helping out so the adjustment ended up being not necessary. I would still reduce some short delta now though. That is not the point really; the point is the market is moving. The tape says so, now how to look at it?

I use my handy Livevol® chart and get a sense of recent realized volatility in 10-day, 20-day, and 30-day moving averages. One thing you note below is that all three have been up lately. That is the tape saying the market is moving and in general I have no interest in getting in the way of that. Not only that but the current 30-day implied volatility is underpricing the current moves after the Tuesday and Wednesday volatility crush. Now you say “Andrew, big deal we had a 2% move on Monday so that will push all of the HV’s higher” and it for sure will. We also just moved all the way to where we started this week on basically no news. We move down big with some news and we rally hard with no news. That is not what we had in January and most of February. Just look at the slack action in all of the short term HV numbers. At least for this week, the tape is acting different. The implied volatility was trading expensive to the movement most of the time prior to this week. Now the IV looks a little cheaper so I want to structure something that owns more ATM options and sells more OTM options.

chart
LivevolX® www.livevol.com
Click to Enlarge

So what to do now? I think the sequester and whatever kettle our politicians cook up is at work here but if they actually follow through on anything, the market likes that. They raised taxes size in January and we rallied. The market likes the certainty of a deficit cutting path. Just read the tape.

The Trade
I think the moves that could push us to new highs are very possible so buy options near the ATM and sell options away from the ATM. A 1 x 2 call spread in the end of March using the Weekly cycle looks interesting with the slightly flatter upside skew we have. Something like the SPY 152/155 (if you don’t have the margin buy a junk upside call to make a broken wing fly). If we tank a bit, just peel off a short call, one at a time. I think the RV is high enough where the next rally should make the trade good.

By Andrew Giovinazzi, Chief Options Strategist, OptionPit.com

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