By Jud Pyle, CFA, chief investment strategist for the Options News Network
Whoever needs proof that fear in the markets has subsided should take a look at the current front-month, at-the-money straddle on
S&P Depository Receipts
vs. a similar straddle at the end of last year, around the time when the
CBOE SPX Volatility Index
was still around 60.
Currently, the SPY is trading for around $91. So the May straddle that is at-the-money now is the 91 strike. The call is currently trading for approximately $2 and the put is trading for approximately $2.18. Recall that we use the term straddle when an investor buys or sells both the call and the put in the same month as part of the same transaction.
In this case, the straddle is trading for $4.18. The breakeven prices, for someone who sold the straddle, are $86.82 and $95.18. So the options market is suggesting that as the likely range of possible prices for the SPY at May expiration next Friday.
Looking back at the December SPY options, we can see just how much more volatility was priced into the market. In early morning trading on Tuesday, Dec. 9, the SPY Dec. 91 straddle traded for $7.25. This is effectively the same straddle as we are seeing this month, with about two weeks to go before expiration, except the straddle closed at $7.25.
So in December, the SPY at-the-money straddle had a price of 7.9%of strike ($7.25/$91). Today, the straddle is priced at 4.5% of strike ($4.18/$91). From this decline, we see how risk premiums have contracted since December. Today, the VIX is around 35%. Back in December, the VIX was around 58%.
Here's a practical example of what it looks like when people say volatility is declining and signs of increased risk-taking are becoming more apparent. The markets are clearly not back to the levels of last summer, but the SPY at-the-money straddle is a clear sign of just how much risk premiums have declined since December.
It's plausible that the market will return to the higher implied volatility levels of December, or even November. But for now, expected market moves (as measured by the SPY straddle) are at their lowest levels in months.
Jud Pyle is the chief investment strategist for Options News Network (www.ONN.tv) and the portfolio manager of TheStreet.com Options Alerts. Click here for a free trial for Options Alerts. Mr. Pyle writes regularly about options investing for TheStreet.com.
Jud Pyle, CFA, is the chief investment strategist for Options News Network. Pyle started his career in finance in 1994 as a derivative analyst with SBC Warburg. After four years with Warburg, Pyle joined PEAK6 Investments, L.P., in 1998 as an equity options trader and as chief risk officer. A native of Minneapolis, Pyle received his bachelor's degree in economics and history from Colgate University in 1994. As a trader, Pyle traded on average over 5,000 contracts per day, and over 1.2 million contracts per year. He also built the stock group for all PEAK6 Investments, L.P. hedging, which currently trades on average over 5 million shares per day, and over 1 billion shares per year. Further, from 2004-06, he managed the trading and risk management for PEAK6 Investments L.P.'s lead market-maker operation on the former PCX exchange, which traded more than 10,000 contracts per day. Pyle is the "Mad About Options" resident expert. He is also a regular contributor to "Options Physics."