With the VIX up .05 to 12.86 as I write this the market is taking a long overdue breather. For the last two weeks through good news and bad, stocks have rallied pretty hard. For instance AAPL has moved a lot but really has gone nowhere. I think the big winner has been GOOG running from around $800 to just over $900 in a two week span. Let take a look at the volatility in there.
On May 3rd the upside skew in GOOG was pointed down in the May 24 Weekly options. I had the ATM volatility around 20% and the 50 point OTM volatility around 17%. We call this a steeper upside curve as opposed to flat since the OTM options are trading for cheaper price pointing the curve down.
I want to characterize today with movement. AAPL trades from 441 to 422, GOOG trades from 894 to 916 and PCLN from 789 to 808. Stocks are moving again and I alluded to that yesterday that the realized volatility for names is starting to pick up. VIX managed up .04 but really the story is that stocks are moving and the reason is money is coming back into the market. I think this means that things that really were not possible with positions most of last year are possible now. You can buy some options and have a shot at making money. Let’s look at a stock in the basement, ZNGA.
The good thing about the stock market is that it is just like the weather in Maine. Wait a day and it will change. We wrote earlier this week that bond volatility was in the toilet and low and behold the market has changed course a bit. Why, the underlying assumptions can always change. There were rumors floating that the Fed might curtail purchases of bonds and that sent the TLT down from 121.25 to 120.10 by the close.
We have the market flirting with all-time highs again today 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
Looking at the rally Thursday on what I would say is so-so news I am reminded of the fact that over the last year most of the melting has been to the upside. The market has tended to take off like a shot with Fed easing and the BOJ declaring war on interest rates. The US market with a decent dividend yield is starting to look attractive all of a sudden. While I am still mild bullish it pays to take a look at how the market is viewing volatility in the near term.
We were closing a position in the SL today and it was a ratio put spread turned into a very cheap (.04) butterfly and my feeling was BBRY is not quite done. Earnings are coming out in the July cycle and some trades that have been working very well lately are the modified earnings plays. What do I mean by that? Well the idea is to own gamma and pay very little in theta for duration of the trade. It is what Mark Longo calls on the Option Block “juice for free”.
One topic that consistently confuses people is VIX curve structure. It’s not just the level; it’s the slope that matters. Let’s look at two curves with very similar underlying VIX prices. I the difference might be more clear.
On March 21st, 2013 the VIX closed at 13.99, a mere .30% lower than where the VIX is trading. Also a very similar number of days to expiration across the different contract months relative to where we are trading today. Notice the slope of the curve in the front two contract months:
This was a weird day. As weak as the market looked all day it felt more like a lack of buyers than an over- supply of sellers. That did not stop the VIX from riding a roller coaster. This reminded me of the 2001 after 9/11. There are a lot of strange vibrations coursing through the market picking up the news bites. This is re-enforcing the tragic and generally gloomy news that we have had since Monday. Mediocre earnings do not help. The earnings were not awful from BAC but there was a sense of baggage on them. Add a Ricin letter and that was enough to keep the buyers away. There a sense of gloom hanging over everything.
With the market recovering some of the sell off yesterday, we look at more mundane features in the market. Redistributing some of AAPL's cash hoard comes to mind. AAPL rallied to the $480’s earlier this year on the new cash payout hype so here we are again looking for another excuse to goose up the stock into earnings.
Let’s review the rules for dividends as it pertains to options.
First- Call values do not like dividends and put values do. A dividend increase will decrease call values and increase put values.
That does not mean that a big cash payout is not BULLISH. It can be, but the dividend will affect the relative movement of call and put options.