Long Term Risk Coming In?
This morning we had another continuation of the Cliff Dwellers saga. This is where the market participants watch and see what the Executive Branch and Congress are going to say and then hit the sell button. It played out it in great fashion this morning on the leftovers from the hardening position talk on both sides in our esteemed government. Note the brisk selloff in the SPY this am. The SPY touched 139 and then proceeded to rally 1.7%+ to close 141.54. What happened?
Chart by ThinkorSwim (www.thinkorswim.com)
Well, both sides are getting pilloried by the press, the public and corporate CEO’s so today’s news of compromise is welcome. Cut spending and raise revenue and get on with it. No one who is breathing has any illusions about that. It would be nice to think we have a little more gumption than the EU. As far as the markets read on the news I thought a survey of the term structure would be interesting in glowing 3D.
Option View Chart from ORATS/Aqumin
This is a live view of the option implied volatility change at the end of the day. Note how the near term (circle 1) is green. This is the SPY Weeklys showing a small jump in IV. Circle number 2 is the inflection right around the Cliff and is about flat. Circle number 3 is showing the far term months. IV is turning down slightly there. Think green up and red down. My thought here is the market is bidding up the Gamma (short term) and fading the Vega (longer term). Mind you this is just an inflection in change in volatility. The bigger move down to around a 13 VIX is yet to happen. With a Greek deal just signed and a recap of the Spanish Banks approved a lot of the big risk problems are dissipating. If the deficit deal can roll downhill we should see a good smoking in longer term volatility over the coming weeks.
Sell the long term Vega by buying ATM puts on the VXZ (this is an illiquid product) in the Jan cycle or buy the Gamma by owning call spreads on the SPY (say 141/144) in one of the Dec Weekly cycles after this last Nov cycle. These are only trades that work if the Fiscal negotiations progress. I like the idea of using these on any dip when the rhetoric gets a bit frosty.
We closed our put calendar from yesterday’s blog for the Strategy Letter this morning.
I have SPY and VXX positions.
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