Volatility Trading Digest - Haircut Strategy
Volatility Trading Digest - Haircut Strategy
With the details of the European rescue plan still being negotiated, including the "haircut", we are expecting volatility to remain high until the G20 summit meeting in Cannes on November 3-4.
If we are right about the S&P 500 Index being in the process of forming a Head & Shoulders bottom another decline to retest test 1100 would be a part of the developing pattern and if so, chances are good it will come from the overhead resistance at the August 31 high at 1230.71, now only 6 points away.
Accordingly, we have a hedge strategy suggestion below using the CBOE Volatility Index (VIX).
Chart of the Week
As a part of our hedge strategy suggestion, here is the chart of the VIX showing its close below 30 for the first time since August 3. Since the S&P 500 Index is near resistance and we are expecting another retest of 1100, then chances are VIX will soon reverse.
CBOE Volatility Index (VIX)
Two weeks ago, we suggested a calendar spread, long the November 40 call and short the October 40 call. At the close on Monday October 3, we booked the options spread for a credit of 1.15 as the futures spread between to October and November widened to 4.50 from 4.40 the previous Friday.
Last Friday around mid day we sent out a tweet saying that we were booking the close of the spread for a .97 credit as the difference between the October and November futures had declined to .25 as the VIX declined below 30.
Adding the initial credit of 1.15 to the closing credit of .97, we booked a total gain of 2.12 in two weeks.
Now however, we think the chances are good that VIX will go the other way so we will open a new spread that should gain in value as the futures spread widens as the VIX rises.
Since the last trading day for the October VIX options is Tuesday, we will select November for the long call and December for the short call as November will be the front month on Wednesday and should rise more rapidly if the VIX turns higher.
On Friday the November futures contract was 29.35 while the December was 28.90 for a difference .45. If the VIX turns higher, we expect the difference will increase, as the November will gain in price faster than the December. Consider this calendar spread.
In the event the S&P 500 Index continues above the August 31 high at 1230.71 and the VIX continues lower, we suggest using a close below 25 as the SU (stop/unwind). Presuming it works as planned use a close back up above 42 as the closing price target.
The suggestion above is based upon last Friday's closing prices using the mid price between the bid and ask. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
Summary
After making a key reversal and then an eight-day run the S&P 500 Index is near resistance at the August 31 high of 1230.71 where we are expecting it to turn lower and retest the 1100 level once again. Volatility should remain higher until the G-20 summit in early November.
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