"We shall not cease from exploration, and the end of our exploring will be to arrive where we started and know it for the first time."
Little Gidding, T.S. Elliot
EXPLORING AN UNCERTAIN LANDSCAPE
While certainly not unexpected, 2016 has been a difficult year for markets; emerging economies are in a state of flux, global currencies are in gimbal lock and esoteric securities are once again raising red flags.
Prior to the current disruptions, global equities enjoyed a prolonged period of growth largely propelled by exponential advances in technology... for better or worse, we've undergone a technical revolution. This is born out in the growth of the tech heavy Nasdaq which nearly doubled the already remarkable performance of the S&P since 2009.
The tech heavy Nasdaq has almost doubled up the S&P over the past 10 years:
Technology is beginning to look weak on a relative basis, however. Over the past two weeks, broad based indices have rallied and even pushed through resistance levels.
Meanwhile, the Nasdaq hasn't benefited from this bounce and is still trading below its 50-day moving average... this is the QQQ:
Given the extended period of growth and the weak short term relative performance, we can now begin to evaluate trading strategies on the Nasdaq using the QQQ.
WHAT TO EXPECT WHEN YOU'RE PROJECTING
The first step is to build the projected performance distribution of QQQ for the proposed period, I'll be using return and volatility assumptions to the March 24th options expiration (19 trading days).
http://tancockstradingblog.blogspot.com/2015/08/projecting-equity-prices-using.html
The expected return figure generated by the optimized exponential trend calculator over the period is -2.75% and the projected/realized volatility for the period is 15.2%. As of this writing, QQQ is trading at roughly $104 a share.
This produces the following return projection chart:
The implied volatility on the at-the-money put offer price is 21.1% which produces a wider distribution:
Again, the projected returns are what we expect to happen and the implied returns represent market expectations as expressed in options prices. QQQ is an index ETF and index volatility is ubiquitously overpriced so it comes as no surprise that the implied distribution is notably wider than the projection.
This disparity does create some interesting trading opportunities.
DIRECTIONALITY IN PRICE & VOLATILITY
Options are dynamic investment tools that allow investors to express their viewpoints on both the direction of an underlying security and the degree to which it will move, or its volatility. When looking at our example of the Nasdaq 100 ETF, QQQ, we immediately notice a couple of things:
Here's a look at the vertical bear call spread where we sell the $102 call and buy the $106:
To sell options while being directionally agnostic, we would structure an iron condor. A typical iron condor consist of four strike prices which equates to two vertical spreads. The goal is to structure a trade that will benefit from theta decay while the price of the underlying security stays in a range. Using QQQ as an example, we can structure a bull put spread using the $100 and $95 strikes and a bear call spread using the $110 and $105 strikes.
Here's the payoff chart from the iron condor (NOTICE: the scale of the x-axis has changed from other charts to illustrate the payoff)
As discussed, I have a bearish outlook on technology and would want to express that using a long volatility profile. Again, this can be done directionally or agnostically.
From a directional perspective, I would build a positive convexity trade using: shares of the QQQ, the $104 put and the $100 put. Here's what the payout looks like:
Whereas, if I wanted to be long volatility and directionally agnostic (or at least less bearish), I could add a ratio of the $104.5 call and my payoff would look like this:
Little Gidding, T.S. Elliot
EXPLORING AN UNCERTAIN LANDSCAPE
While certainly not unexpected, 2016 has been a difficult year for markets; emerging economies are in a state of flux, global currencies are in gimbal lock and esoteric securities are once again raising red flags.
Prior to the current disruptions, global equities enjoyed a prolonged period of growth largely propelled by exponential advances in technology... for better or worse, we've undergone a technical revolution. This is born out in the growth of the tech heavy Nasdaq which nearly doubled the already remarkable performance of the S&P since 2009.
The tech heavy Nasdaq has almost doubled up the S&P over the past 10 years:
Technology is beginning to look weak on a relative basis, however. Over the past two weeks, broad based indices have rallied and even pushed through resistance levels.
Meanwhile, the Nasdaq hasn't benefited from this bounce and is still trading below its 50-day moving average... this is the QQQ:
Given the extended period of growth and the weak short term relative performance, we can now begin to evaluate trading strategies on the Nasdaq using the QQQ.
WHAT TO EXPECT WHEN YOU'RE PROJECTING
The first step is to build the projected performance distribution of QQQ for the proposed period, I'll be using return and volatility assumptions to the March 24th options expiration (19 trading days).
http://tancockstradingblog.blogspot.com/2015/08/projecting-equity-prices-using.html
The expected return figure generated by the optimized exponential trend calculator over the period is -2.75% and the projected/realized volatility for the period is 15.2%. As of this writing, QQQ is trading at roughly $104 a share.
This produces the following return projection chart:
The implied volatility on the at-the-money put offer price is 21.1% which produces a wider distribution:
Again, the projected returns are what we expect to happen and the implied returns represent market expectations as expressed in options prices. QQQ is an index ETF and index volatility is ubiquitously overpriced so it comes as no surprise that the implied distribution is notably wider than the projection.
This disparity does create some interesting trading opportunities.
DIRECTIONALITY IN PRICE & VOLATILITY
Options are dynamic investment tools that allow investors to express their viewpoints on both the direction of an underlying security and the degree to which it will move, or its volatility. When looking at our example of the Nasdaq 100 ETF, QQQ, we immediately notice a couple of things:
- Expensive Premiums - The price of the options are high relative to the projected movements of the index over the time frame.
- Price Directionality - The QQQ appears to be in a bearish trend pattern and it recently reverted back up to its 50-day moving average. This presents an opportunity to put on a bearish directional trade.
Here's a look at the vertical bear call spread where we sell the $102 call and buy the $106:
To sell options while being directionally agnostic, we would structure an iron condor. A typical iron condor consist of four strike prices which equates to two vertical spreads. The goal is to structure a trade that will benefit from theta decay while the price of the underlying security stays in a range. Using QQQ as an example, we can structure a bull put spread using the $100 and $95 strikes and a bear call spread using the $110 and $105 strikes.
Here's the payoff chart from the iron condor (NOTICE: the scale of the x-axis has changed from other charts to illustrate the payoff)
As discussed, I have a bearish outlook on technology and would want to express that using a long volatility profile. Again, this can be done directionally or agnostically.
From a directional perspective, I would build a positive convexity trade using: shares of the QQQ, the $104 put and the $100 put. Here's what the payout looks like:
Whereas, if I wanted to be long volatility and directionally agnostic (or at least less bearish), I could add a ratio of the $104.5 call and my payoff would look like this:
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