As stock markets around the world grind higher, short-term implied volatility is making year lows, notes Mark Sebastian of OptionPit.com, who offers a trade idea based on improving global economic conditions.
We have the market flirting with all-time highs again and investors should be beginning to wonder if the financial crisis is over. Asia looks ok, India ok, Latin America ok, and the US recovering but in a pokey big government way. Europe is still a basket case but that is mostly due to the reluctance of a good chunk of the population to work for a living and for the governments to stop paying for it. At least short term, the euro should stay intact while the drudgery of budget discipline starts to happen. While I won't declare the financial crisis dead there is plenty of anecdotal evidence for that. TARP was a success, Fannie and Freddie could pay back what they owe, and home mortgage payments are now cheaper than rents in many places. Take a look at the risk management tool of the last four years and see what is up with that.
I will use the TLT as a proxy for US government bonds and short-term implied volatility (IV) is making year lows. Below in the option landscape May IV at the money is trading 9.7%. That is the low for the year. Note how the IV is dropping all down the term structure as well. Not as much as the smack down in the front two weeks but still coming in nonetheless.
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To look at end of the day skew change, go here.
Near-term IV is the fastest way to gauge the market's potential movement and right now options say that is not very much. The volatility market at least is saying the big down move we just saw will start to slow to a trickle. Not much is going to change on the part of the Fed and the volatility traders are starting to believe it. If you follow the logic that the financial crisis is easing somewhat owning a cheap downside butterfly in Jun would work the best.
The Trade
Something like the Jun 120/117/114 strikes and just let the TLT drift lower. The panic premium should drift out of the TLT, but really only slowly.
By Mark Sebastian, Blogger and Contributor, OptionPit.com
