Witch Way Will This Market Move?
"Triple witching" is a term normally reserved for quarterly options expiration dates, when the interplay of expiring futures and options can lead to unusually large market swings. These times are among the most stressful for traders, who often find themselves afraid to run to the restroom for fear they will miss a move. While outside of the traditional definition, this week's combination of elections, FOMC action and payroll data are providing a similar dynamic, as traders brace for reactions to the headlines.
Combined with memories of the market declines in October 1929, 87 and 89 and Halloween, I believe this week has to qualify for honorary "triple witch" status. Observation of option flow heading into this week showed growing concern about a move, as the CBOE Volatility IndexI:VIX climbed steadily from $19.00 to $21.50 over seven sessions, despite a relatively positive market trend.
One of the largest plays heading into this week involved options on Bank of America (BAC) - Get Report. On October 22, with shares trading at $11.48, a buyer paid $0.12 for 160,000 November 10 puts to open a new position. While a relatively low priced option, the position is very large, potentially a short-term hedge struck 13% out of the money for a position of 16 million shares.
A positive reaction to the Fed's plans has helped the broad market continue to climb (up 14% since early September) and cut option risk premiums, evident in the two point VIX crush that took place immediately after the news. One benefit to traders who have a core-long position is a reduced cost of hedging.
At this point I would consider a collar on The SPDR S&P 500 ETF (SPY) - Get Report to protect recent gains through year end. Currently the SPY January 115/124 collar is trading near a $0.10 credit to sell calls and buy puts. This trade provides a downside hedge struck about 5% out of the money, in exchange for the upside gains beyond $124.00.
Trades: Buy to open 10 SPY January 115 puts for $2.19 and sell to open 10 SPY January 124 calls at $2.29.
At the time of publication, Henry Schwartz was long SPY.
Henry is the president of Trade Alert LLC, a provider of real-time options analysis tools to leading Wall Street firms. His systems analyze hundreds of thousands of transactions per second to help professionals identify and interpret market activity in real time, supporting informed trading decisions and intelligent idea generation.
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