Trading Options With The Return Of Volatility

| August 16, 2017 | 0 Comments

volatilityRight now, thousands of short volatility traders are scrambling to cover their positions. Okay, that’s an exaggeration – they’re probably just rolling their positions higher. Joking aside, there’s nothing like a nuclear threat to get some volatility back in the financial markets.

Yet, two or three days of higher volatility probably isn’t going to change the buy-the-dip/sell-volatility regime we’ve been in for the last several months (years?). We’ll obviously have to wait and see if the VIX and other volatility metrics retain a higher floor once the markets settle down.

Realistically, we’re probably not going to engage in a nuclear missile battle with North Korea. In fact, I’d be surprised if the US takes any form of military action anytime soon given the impact it could have on our close allies, South Korea and Japan. It’s probably going to be nothing more than a war of rhetoric. Still, there’s enough uncertainty out there for the VIX to notice.

You can see from the chart of the VIX, this isn’t your typical one day spike. The “fear index” didn’t revert back to previous levels in the next day like we’re used to. What’s more, the spike was clearly higher than the other minor spikes we’ve had this year.

As you can imagine, there’s been plenty of action in the VIX and other volatility funds. Some traders are placing long positions for speculative reasons. Many traders will be going short, assuming a quick reversion to the mean. And of course, plenty of short volatility traders have covered losing or risky positions.

SPDR Gold SharesIf trading volatility directly isn’t your thing or you want to avoid all the noise from the short sellers, there’s also gold to consider. Remember, gold still acts as a safe-haven investment, and many investors use it as a hedge against uncertainty. Take a look at the chart of the SPDR Gold Shares (NYSE: GLD).

You can see the price of gold spiked on the North Korea nuclear news. Now, if the rhetoric settles down, it looks gold is about to hit a key resistance point and it will quickly sell off. On the other hand, there could be significant upside if the price breaks through the current level.

Of course, I have a good idea for the kind of options trade I’d like to do here, but let’s first look at what some big options traders are doing in GLD this week…

With GLD a touch over $122, one trader purchased 1,000 January 2019 130 calls for $6.50. That’s as far out as the option chain goes (on the time horizon) and cost $650,000 in premium. Breakeven is all the way up at $136.50, but of course there’s a year and half before expiration.

Another big trader scooped up 8,000 of the June 2018 150 calls for $0.98. That’s about a year away but breakeven is even higher than the previous trade, up to around $151. The trader dropped nearly $800,000 in premium for these contracts.

So what’s the deal with these long term out-of-the-money GLD calls? My guess is these are funds or big portfolios doing long-term hedges. When volatility spiked due to a major macro event (nuclear missiles!), fund managers probably decided it was time to hedge some of their risk using gold. That’s not to say these can’t possibly be speculative positions, but I would guess at least the 8,000 150 calls are hedges.

There were plenty of short-term bets in GLD too. Many of these were bullish, as expected. For instance there was a 1,000 call vertical spreads purchased, expiring September 15th, long the 124 short the 127. This particular trade has max profits at $127 and breaks even around $124.50. But overall, most of the short-term bullish trades were much smaller in size and dollar amounts.

Personally, I think there’s a good chance gold will remain elevated for the foreseeable future given the nature of the threat (nuclear missiles!). However, I’m not sure it’s going to go on a crazy run higher either. Whatever happens, I don’t believe GLD will be sitting at its current level ($123) come September expiration.

As such, I suggest this is yet another great time for a long GLD straddle. The September 15th $123 straddle isn’t cheap – it’s about $3.75 – but makes sense given the macro environment. I believe there’s a good chance GLD will be over $126.75 or below $119.25 in a month or so. In that case, this trade will definitely pay off.


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Category: Options Volatility Watch

About the Author ()

Jay Soloff is an options analyst with Investors Alley.