All on Vol

Jared has forgotten more about options than I have ever known.  Below he has graciously agreed to share a few issues of his paid newsletter Volatility Tracker with Idea Farm subs.

Below is an excerpt of a few trade ideas before the downloads:

Trade Ideas

Investors can take advantage of the rich implied volatility and elevated upside volatility skew in Twitter options in several ways, depending on the outlook for the underlying. Note that shares were listed as hard to borrow at several brokers, so pure arbitrage plays and any delta-hedging strategy components may be difficult or impossible to execute for now. Trades are based on the Dec. 26 closing price of $73.31.

1. Bullish call diagonal: Buy June 2014 $72.5 calls at $16.00 and sell January 2014 95 calls at $2.45, rolling
25 delta call sales monthly.

The skew in OTM calls makes covered call and buy-write trades more attractive than usual. Typically, equity options at higher strike prices are priced at lower levels of implied volatility. As a result, investors pursuing buy-write strategies forego returns beyond the call strike in exchange for relatively modest option premiums. That disadvantage is not present here. Additionally, since the term structure of IV is backwardated, in lieu of buying shares, investors looking to get long stock can buy less expensive longer-dated calls and sell rich short term calls to benefit from bullish sentiment and elevated skew. The intent is to roll the short call leg before expiration, selling new calls with option-implied deltas closest to 25 to finance the long call leg.

2. Bearish risk reversal: Buy February 65 puts at $7.60 (101% IV) and sell Feb. 80 calls at $9.50 (108% IV).

For traders who wish to establish outright short positions, a bearish risk reversal has two advantages: the position will benefit more than a short sale if the directional view proves correct and call skew declines accordingly. Second, even if a bearish outlook proves wrong, the trade will still be profitable with shares below $81.90 at expiration, since the position is opened for a net credit of $1.90. We are looking in the February cycle for this trade to allow more time for the short-term trend to play out and reverse.

3. Neutral call ratio: Buy two January 75 calls at $7.10 and sell three January 80 calls at $5.30.

The trade takes advantage of skew by selling more higher strike calls, which can be expected to decay more quickly if the underlying becomes range-bound or declines. There is no downside risk, since the initial $1.70 credit will be kept on a close below $75 at expiration. The position should generate a profit of $7.00 or greater with the stock between $77 and $85 at expiration. Mark to market risk is greater than the initial credit above $79 in the very short term, but because this trade gets short more deltas as the stock price rises, the position can be effectively delta-hedged with long stock to reduce the risk of a sudden rally in the next several weeks.

Download PDFs

Dec 16th Update

Dec 26th update

Volatility Tracker