No pay for 3 months how about the last 18 months?

I don’t want to pooh pooh the rally we have had recently.  After 3 years or so of the governments from both sides of the Atlantic trying to “manage” the economy, some of the shackles are starting to break off.  Europe does not even make front page news anymore, as the Euro is making some short term highs.  Mario should thank Ben.  Most, if not all, of the economic data has been improving, as houses are selling, and most businesses are generating decent earnings.  With the super low interest rates and giant chunks of liquidity from the Fed the US is set to grow.  I don’t know what Ben is going to do with his big balance sheet, but I guess he will figure that out.  One stumbling block remains, and that is level of spending by the US government.  The temporary stimulus of 2009 has become a permanent part of the spending landscape.  The issue is priced out in the options.

In 2011, much of the volatility market was caught flat footed after the downgrade on the quality of US debt.  That ignited a rally in the Treasury paper but shook equity markets down to post crisis lows.  The Fiscal Cliff deal helped to bring in some revenue, but the government still seems incapable of cutting spending. 

If you look, below was reflected in the term structure for the SPY or any of the big indexes on the close yesterday.  The front 5 weeks of expiration is much lower than the mid-March cycle.  The March and beyond implied volatility towers have higher IV that is not totally explained by normal contango.  There was a small rally in very short term volatility in the cycle expiring Jan 25^th.  Those are the dark green buildings in the second column from the left.

OptionVision

Near the end of today, the market for short term IV imploded (see below).  The announcement that the Republicans were offering to forgo pay unless they can pass a budget in 3 months took all of the steam out of the volatility.  My guess is that some of the volatility will come back at some point in the haggling, but at least for the short term, the volatility market had the mark down near term pretty well pegged.  At this point, we will go into next week without a politically contrived crisis on the horizon that is printed on a calendar, theoretically anyway.

OptionVision

The Trade

I would like to see how all this shakes out.  I still like the short term Iron Butterflies in the indexes with the realized volatility around 6%, while the market decides what to do.

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