- Stock-market volatility has remained low this year even though various gauges of uncertainty have surged.
- According to BTIG’s Julian Emanuel, this combination means that volatility is primed for a sharp move higher.
- He offered options trades that are poised to profit from sharp moves in the market, be they up or down.
Stock-market volatility is good for investors on several fronts.
Sure, it can wipe out several years of gains in a few minutes at its worst. But it also creates tactical opportunities for traders to profit from sharp moves in either direction.
When it comes to the latter, there’s virtually no better way to capitalize on big market moves than the options market, according to Julian Emanuel, the chief equity and derivatives strategist at BTIG.
"Whether you are hedging, speculating, or trading vol, the cost of being wrong using options has seldom been lower," he said in a recent client note.
His case for trading options is grounded in his view that stock-market volatility is primed for another spike.
"In many ways the quiet is almost eerie, given the uncertainties, the last six months’ market action and the absolute low levels across assets," Emanuel said.
He pointed to China, North Korea, the US debt ceiling, Brexit, and the outcome of the Mueller investigation as some of the significant risks to equities that investors face right now.
None of these existing (and rising) risks confronting investors have been enough to deter the market’s gradual march higher this year. While volatility remained low, various gauges of geopolitical risk — from the GeoQuant political risk score that Emanuel highlighted to the Economic Policy Uncertainty index — surged to the stratosphere, as the two charts below show.
Emanuel specifically recommended options straddles, a strategy that involves simultaneously buying a put option that bets on a security’s rise, and a call option that bets on its decline with the same strike price and expiration date. A trader profits when the security’s price rallies or falls from the strike price by more than the cost, or premium, to buy the option.
His trade recommendations, quoted below, are for the S&P 500, the iShares China Large-cap ETF (FXI) and the Invesco DB US Dollar Index Bullish Fund (UUP). All commentary is presented in Emanuel’s own words.
- While we do not have a firm view on where the next 10% move is headed (potential "urgent" buying above 2,813 or disappointments sending prices back toward support at 2,600) on the road to our year-end price target of 3,000, we believe there is value in owning options – buying the SPX September 3,000 Call/2,500 Put "strangle" to capitalize on the potential for increased volatility in the weeks ahead.
- The FXI June 42.5 straddle – buy June 42.5 calls ($2.18, 21.1% Vol, 57 Delta) and buy June 42.5 puts ($1.87, 21.1% Vol, -47 Delta) – is an example of an options strategy that benefits from increased volatility, regardless of price direction.
- UUP implied volatility has fallen to its lowest levels since 2014 as the dollar regained its footing this year (Figure 26). The UUP June 26 straddle – buy June 26 calls ($0.39, 4.6% Vol, 62 Delta) and buy June 26 puts ($0.38, 7.8% Vol, -45 Delta) – is an example of an options strategy that benefits from increased volatility, regardless of price direction.
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