Of late, volatility has been volatile. Twice in the past 15 sessions the Volatility Index (VIX) has surpassed 16, only to quickly reverse to the downside. It’s also broken below 12 three times, only to reverse to the upside.
The SPDR S&P 500 ETF (SPY) has had its share of wild swings. It is still range-bound – trapped between 204 and 213 (see chart 1 below). Where then might it be headed next? Better yet, might options be a better way to play the ETF in the near-term? Let us dive in and try to find out.
Last week’s action on SPY, combined with the Wednesday reversal, is encouraging if you are a bull. Although the distance between the 50- and 200-day moving averages is a mere three points now – the lowest since January 9, 2013 – and is narrowing. A death cross is possible in the not too distance future as well. And monthly momentum indicators are beginning to come under pressure.
The point is, in the near-term there is fodder for both bulls and bears. The former – now that the earnings season is unwinding – expect buybacks to resume in earnest. The latter points to the rapidly deteriorating earnings picture. Within a couple of weeks, 2015 operating earnings estimates for S&P 500 companies have dropped by nearly $3 – from $114.73 on July 30 to $112.25 on August 6 to $112.03 on August 10 to $111.88 on August 13 (Chart 2). Earnings were $113.02 last year, so we are now looking at a down year.
This probably explains why short interest remains high. At the end of July, short interest on the S&P 500 ETF (SPY) stood at 309 million shares, down nearly 11 percent two weeks ago (see chart 3 below). Interestingly, SPY was flat during this period, but did rise to $213.18 before reversing. That spike – testing May and June highs – must have caused a mini squeeze.
If bulls are able to regroup, and those highs are tested again – or even surpassed – the elevated level of short interest is a potential tailwind for stocks. In this scenario, Chart 4 below is highly relevant – the red line in particular.
The chart plots the 21-day moving average of the CBOE put-to-call ratio and the call-to-put ratio of the ISE index, all equity. As of Friday, the ISE reading was the lowest since 118.9 on December 5, 2008. However, the CBOE reading in that session was .856, having peaked at .861 three days prior. Currently, the ISE reading is very low, the CBOE ratio not as low. Friday, the green line only stood at .706, with the most recent peak of .708 on July 27 – the highest reading since .713 on November 23, 2012.
Further, if non-commercials had their way, they would love to see the S&P 500 ETF head south. As of August 11th, net shorts on S&P 500 futures were north of 162,000 contracts – at a five-week high and the second largest in over three years (see chart 5 below). These traders are bearish.
So where to from here? Considering that the VIX seems to be itching to go lower near-term, SPY’s path of least resistance is probably up. The ETF has seen some accumulation in recent sessions. With that said, it has been range bound for three months now, and will require real force for a breakout.
Assuming the range-bound action continues – at least this week – here is a hypothetical iron condor trade using weekly options that I am watching for.
August 21st SPY 204/207/210/213 long iron condor trade
Long 213 call for $0.08
Short 210 call for $1.04
Short 207 put for $0.57
Long 204 put for $0.22
The trade would net a credit of $1.31; $1.69 is at risk. Breakeven is $211.31 on the upside and $205.69 on the downside. These are essentially two vertical spreads – a bear call spread combined with a bull put spread.
The thinking behind the iron condor trade is that SPY ($209.42) this week stays within the recent range. Maximum profit will be utilized if it ends the week between $210 and $207.
Thanks for reading!
Twitter: Â @hedgopia
No position in any mentioned security at the time of publication. Â Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
