With both stocks and bonds finally having relatively “muted” moves last week, we saw large declines in volatility for both. VIX saw a decline of more than 20% (from ~ 37.5 to 29.5) while TLT 1-month implied vol declined by ~ 25% (from 24 to 18). It was exactly this type of action I was expecting in both stock and bond volatility that made me suggest short vol strategies last week (here).
VIX dropped from ~ 37.5 to below 30 as equity markets closed the week down small after initially opening higher
Bond (TLT) 1-month implied volatility also had a large decline as bonds managed to post a small gain after their huge selloff the week before
Looking at stocks (SPY) now, I still think downside risks still outweigh upside gains in the short to medium term (especially given how poorly the Mag7 names continue to trade). However, with the index now right in the middle of the “new” 480-570 range, and upside call vol having come in very sharply, I now favor owning put spreads once again over put spread collars like I suggested last week (when SPY was ~ 3-4% higher and upside call vol was still closer to 30 vs a current 22). The fact is, SPY remains ~ 10% above the recent lows, 1-month 40-delta implied vol is now a more “reasonable” 26 (while 30-day realized vol is ~ 45) and put skew is still elevated. Especially as we head into the heart of earnings season, with the Mag7 continue to underperform the overall tape, I still believe owning May hedges at this time makes a lot of sense. Here is a limited-risk hedge trade I would consider owning now:
Trade:
Buy SPY May 510 put (32d, 28.9 IV)
Sell SPY May 470 put (11d, 35.9 IV)
Costs ~ $6.10 (SPY 526.41 Thus close ref)
- Buying the 40-point wide 1-month protective put spread that starts ~ 3% below spot
- Hedge structure has a 5.5x to 1 max payoff at May expiry and is capped to the downside below the recent lows
- Trade captures 7 points of vol skew
- While I continue to believe mkt upside is capped at the 570 area for now, I don’t like the risk/reward as much of selling upside calls given move lower in index and in upside call volatility/premium
- May hedge will capture earnings from all of the Mag7 names (besides NVDA)
SPY closed last week at EXACLTY the 50% retracement from the late March and the early April lows. Wouldn’t be a huge surprise to see a re-test of the lows
Bond (TLT) repair trades still look very attractive
Last week I suggested buying the TLT June 88/94 1×2 call spread as an overlay “repair” trade for bonds following their sharp decline. With bonds up small, and implied vol down sharply, the trade has performed very well thus far. Perhaps the most interesting aspect of the trade is all of the gains have come from the short calls portion (even though TLT was up last week). So even with vol in June down from ~ 22 to 18, I still think this trade should continue to work well as an overlay trade to an existing long bond/duration position. However, with vol now lower, and the initial trade now decidedly more expensive, I would now suggest a “tighter” 1×2 June overlay trade that is also slightly long notional and costs ~ same as the original trade I suggested last week.
Trade:
Buy TLT June 88 calls 1x
Sell TLT June 93 calls 2x
Costs ~ $0.85 (TLT 87.53 price ref as of Thurs close)
- Buying the at the money June 1×2 call spread as a repair/overlay trade following sharp decline in bonds
- Trade will outperform between 88.85 and 97.15 by June expiry (+1.5% to +11%)
- Trade is slightly long delta notional to start as well as theta positive
- Essentially the same trade I suggested last week, but tightening the spread by $1 to keep cost same
- Still think TLT vol should continue to come down as long as long-end yields stay below 5%
TLT June 1×2 call spread overlay trades continue to look very attractive as a way to play for a move back higher in the range it has traded between since October
