Equity markets saw their huge upside momentum continue last week, with Nasdaq + 6.25%, SPX +4.5% and small caps + 5.5% . Continued optimism of a peace agreement in the Middle East helped propel the markets higher for a third straight week. To put this rally into context, the relative strength index (RSI) for the tech-heavy Nasdaq (QQQ) moved from “oversold” to “overbought” in just over 2 weeks, moving the index from a 7-month low to an all-time high at the same time.
QQQ with a 17% rally off the March lows. We also saw the RSI go from the most oversold to most overbought in just over two weeks
While the indices have continued to march higher, I started closely watching the front-month (May) VIX futures last week to see how volatility was behaving. What I noticed was that even though markets continued to rally on a daily basis, making new highs, May VIX futures were essentially flat from Tuesday morning thru the Friday close. To me, this is a very important distinction since vol was telling us (for now) that there could be a quasi-floor at current levels. The SPX (SPY) gained 3.25% from the Tuesday morning open to the close on Friday, yet VIX futures were basically flat.
May VIX futures dropped from 27 to 20 as market rallied, but have been unable to close at new contract lows
May VIX futures were basically flat from the Tuesday open thru Friday close
SPY gained 3.25% from the Tuesday open thru the Friday close
If VIX is unable to move meaningfully lower, even as markets continue to rocket higher, it makes owning VIX calls/call spreads an especially attractive proposition as a macro hedge. For example, the VIX May 19th 25 calls traded ~ $1.20 – $1.25 on the Tuesday open and closed the week worth ~ $1.12 (for a 4-day loss of less than 10% on the hedge). A comparable SPY May 15th 30-delta put bought on Tuesday would have lost more than HALF it’s value over the same 4 days (and the delta went from 30 to 15). The recent action in VIX, coupled with the massive gains we have seen in just the past few weeks, makes VIX upside May structures a “must own” in my opinion. With the negative weekend headlines on Iran I suspect that VIX is likely to open higher on Monday, but I would still look to tactically add upside May call spreads, especially if/when we see the market rally (and VIX move lower).
Trade
Buy May 19th VIX 23 calls
Sell May 19th VIX 45 calls
Costs ~ $1 (May futures ref of 20.29 – Fri close)
Trade Details:
- Buying the May VIX call spread as a macro portfolio hedge following sharp equity rally and decline in volatility
- VIX has been unable to make new contract lows, even as market has continued higher the past four days
- Trade offers a better than 20x to 1 max payout on the limited-risk bet/hedge
- Call skew is VERY attractive with the tail calls (45 strike) trading at a huge vol skew to the closer to the money 23 strike calls (selling 170 vol to buy vol ~ 100)
- Selling the 45 calls covers 25% of the cost of the higher delta 23 calls
- Trade has 30 days until expiration (consider where volatility and markets were just 20 days ago)
- Please reach out to me or the 22V sales team for updated pricing and execution capabilities
Upside call vol continues to move higher as the closer to the money call vol has come in. Call skew now at the highs and favorable
Energy sector ETFs have lagged even with oil considerably higher
While the markets have made new highs, the main energy ETFs (XLE and XOP) have performed very poorly. Oil is still UP over 40% since the start of the war with Iran, yet XLE is DOWN 1% over that time and XOP is essentially up the same 4% the SPX is over that same time. I get that perhaps markets have been discounting lower oil from here (assuming we actually get a peace resolution), but the fact that XLE is down since BEFORE the conflict started probably will surprise you. Both XLE and XOP are down ~ 13 to 16% from their highs, and I believe both look interesting in terms of adding upside exposure.
What I also find very interesting is that upside call volatility for both XLE and XOP is now LOWER than before the conflict as well. Looking at the 40-delta May calls for both, XOP call vol is down ~ 3 points since the end of Feb, while XLE call vol is down ~ 6-7 points. I believe this combination of pullback from the highs, decrease in upside call volatility and underperformance to overall market makes buying upside May calls a compelling proposition. Much like with VIX, I would expect that given the weekend headlines that oil is likely to be higher on the Monday open, but I would use any pullback in oil to add XLE and/or XOP upside May calls.
1-month (May) 40-delta call vol for XLE and XOP are both lower than they were before the war started
Two trades I suggest:
Buy XOP May 15th 165 calls for ~ $3.75 (XOP 159.59 Fri close ref)
Buy XLE May 15th 56 calls for ~ $1.25 (XLE 55.02 Fri close ref)
Trade Details:
- Buying the 1-month 40-delta calls in either of the main energy ETF’s following 13-16% pullback in both
- Have seen implied vol move lower for both and they both now trade at CHEAPER vols than before the conflict started
- XLE is actually lower than before the war started, even though oil remains ~ 40% higher
- Defined-risk way to add exposure to the energy names following sharp pullback from the highs
- May expiration also captures earnings for most of the larger energy names (another reason I favor the tactical call purchase)
- Please reach out to me or the 22V sales team for updated pricing and execution capabilities
XLE down more than 13% from the highs and below the level it was trading at before the conflict started
XOP with a 16% decline from the highs as well
