Massive volatility declines in both stocks and bonds post-election
Not only because the election is behind us, but the fact that the results were so decisive, both likely contributed to the sharp volatility decline we saw across most asset classes last week. The fear of perhaps another contested election, that could have dragged on and on, likely contributed as much to the large spike we saw in both stock and bond volatility pricing into the election as whatever the results were going to be and the impact on markets. With that now off the table, not only were both stocks AND bonds able to rally last week, but VIX registered its largest weekly decline in nearly 3 years and bond (TLT) 1-month vol dropped by more than 30% (charts below).
VIX index declined by more than 30% last week (back to the August lows) for its largest weekly decline in three years
Bond (TLT) implied vol also had a huge decline – with 1-month implied vol dropping more than 30% as well
Option volatility pricing for stocks is cheap again – own it here
Regardless of market viewpoint, I believe it just makes sense to own vol here thru year-end. As far as the main S&P index (SPY), a case can be made to own cheap upside calls as an added “kicker” in case the post-election market momentum continues. SPX is up 27% YTD, so I looked back over the previous 10 years to see what the market did in November and December in years where the market gained 20%+. In those 4 years where market gained 20%+ the average gain in November and December was ~ 7%. So even though market is up sharply year to date, it is not out of the question that it could just keep grinding higher. I would consider the SPY Dec 615 calls for ~ $3.90 (SPY 598.19 ref) as a cheap upside year-end flyer. These calls are set 2.8% above current levels, and trade at an implied vol ~ 11.4 (just above the August lows). Owning these cheap upside calls will also allow for investor flexibility (can reduce equity longs should the calls trade in the money and delta increases).
The other upside trade I want to highlight is in the small caps (IWM). Back on 10/13 I wrote about the attractive setup for small caps to breakout and how to play that via options. We got that breakout last week with a resounding 8.74% gain on very heavy volume (especially on the day following the election). Even with the sharp gain last week we believe small caps can not only continue higher but outperform large caps (this is a theme 22V has been echoing for a while now). The IWM/SPY relative spread appears to be on the brink of breaking above the most recent downtrend that started in March this year (chart below). If targeting a new upside trade for IWM I suggest playing for a breakout above the all-time high ~ 245. A move above this level not only would confirm the breakout from last week but would also likely attract more quantitative/momentum money. While IWM implied volatility also came down sharply last week, the upside Dec 25-delta calls still trade at an implied vol ~ 21 (or nearly 2x where SPY calls trade). Therefore, while I still like owning upside IWM call structures into year-end, I believe call spreads are the more attractive structure to own at this time. A trade I suggest here is to buy the IWM Dec 245/265 call spread for ~ $3.63 (IWM 238.12 ref). This upside call spread starts less than 3% above current levels right at the all-time high and offers a 4.5x to 1 max payoff at expiration.
Please contact me or the trading desk to get updated pricing on either structure.
IWM/SPY relative spread on the brink of breaking above the downtrend it has been in since March
Now that IWM broke above recent resistance, would be targeting a breakout above the all-time highs ~ 245
