An Options Trade for Worry Warts

03/26/2014 8:00 am EST

Focus: OPTIONS

Andrew Giovinazzi of OptionPit.com offers a trade idea for a market that can't seem to make up its mind.

Stocks sniffed all-time highs again and pulled back from the brink. The simple answer is there is no reasonto be running at all-time highs. That was enough to push stocks back off of their shiny new plateau. Since we are a volatility shop, let's look at the underlying currents. The first stop is SDEX, it's still at nosebleed levels.

chart
Charts by google finance
Click to Enlarge

Next, if you look at the 3D skew, ATM IV is coming in but the further one moves OTM, the rate of decline seems to taper. That would be the highlighted row moving right to left. What that means is there is a lack of willing sellers of downside puts.

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3D skew by OptionVision
Click to Enlarge

The Fed broached the possibility of raising rates, which means there is a bit more economic activity than they are letting on. The 90s went along quite well with rates that would be considered usurious right now. Those masses of capital out there sitting around are definitely not selling puts.

The Trade
My simple advice is to avoid buying the OTM options. I still like the QQQ as much of that index is in tech-heavy, relatively low-multiple names. The best trades would be to go out six months, buy an ATM call and near OTM put spread and sit and wait. If the skew buyers are right and they start to dump their puts, it would be a good time to lighten up on the spread in this strangle. If they give up earlier and you start to see the SDEX fall apart we are either bouncing or off to new highs.

Disclosure: Positions in QQQ names

By Andrew Giovinazzi, Chief Options Strategist, OptionPit.com

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