Option Implied Volatilities Will Contract, Uncertainty Will Dissipate

10/08/2015 8:00 am EST

Focus: OPTIONS

Options trader Pete Stolcers, of OneOption.com, details how—by selling out-of-the-money put credit spreads two weeks ago—he was able to distance himself from the action and take advantage of inflated option implied volatilities.

Posted 8:30 AM ET Wednesday—The market tested the low close from August one week ago and it bounced off of SPY $187.20. After a soft round of news Thursday, stocks held strong and they weathered a dismal jobs report on Friday (148K). Buyers stepped in and the S&P 500 rallied 100 points off of its low in a 24-hour period. We took a breather Tuesday, but the price action Wednesday morning is strong.

Global markets are pushing higher and China will reopen Wednesday night. It has been closed during this rebound and it will try to catch up. The PBOC has done everything in its power to stabilize its economy and its market.

Earnings season will kick off Thursday, but the major releases won’t start until next week. The strongest companies announce early in the earnings cycle and the bid will strengthen each day.

Asset Managers who didn’t buy the dip will get anxious. Most of them missed the last 100 S&P points and stocks are not going to retrace. They don’t want to miss a yearend rally.

The FOMC minutes Thursday won’t mean much. The tone could be hawkish, but that does not factor in last week’s Unemployment Report. As much as the Fed wants to hike rates in 2015, they won’t. Conditions are too fragile and they don’t want to dampen holiday spending. I believe the first rate hike won’t come until March.

Bond yields are at historic lows and equities are attractive on a relative basis. Corporate buybacks are hitting record levels and the number of shares outstanding has been cut in half the last ten years. This is a very powerful force and simple economics dictates that rising demand and falling supply will result in higher prices.

I am not looking for a runaway rally, but we should be able to easily challenge resistance at the upper end of this trading range in the next two weeks. If we break through SPY $202 we could run up to SPY $205. There are a number of dark clouds that will keep a lid on the rally, but we won’t worry about that for at least a month.

Two weeks ago I started selling out-of-the-money put credit spreads. Given the overnight market volatility, this was the only strategy that made sense. I was able to distance myself from the action and take advantage of inflated option implied volatilities. If you did not enter these trades a week ago, you missed the move. These positions are in fantastic shape with a little more than a week to go.

I also sold VXX short. Option implied volatilities will contract as the market moves higher. Uncertainty will dissipate. The Fed will not hike in 2015, China will stabilize, and corporate guidance will be decent during earnings season.

Monday I bought some deep in-the-money calls on stocks that were breaking out. The deltas were above 80, I don’t want to buy time premium. This is a surrogate stock position and the options will almost move point for point with the underlying. My call purchases are a relatively small portion of my overall portfolio.

I feel that I can capture the remainder of the rally intra-day and I will day trade stocks. I have 4:1 margin and stocks are much more liquid than options. Furthermore, I can keep my overnight risk to a minimum.

I have a very specific pattern that I look for. Tuesday we caught SGY in my chat room and we made 13% in a matter of hours (unleveraged). We also caught UNT and we made 16% on that stock in a matter of hours (unleveraged). The trades are coming in fast and furious and I will be doing the same Wednesday.

Look for a nice rally on the open. Wait for the excitement to wane and then get long.

Focus on stocks that are breaking through horizontal resistance. These breakouts tend to produce sustained moves.

I have a very nice portfolio of neutral to bullish trades and my day trading will be the icing on the cake.

Stocks should move higher for at least another ten days.

chart
Click to Enlarge

By Pete Stolcers of OneOption.com

Related Articles on OPTIONS