Options Market Update January 4, 2016

 
The three major indexes closed the year with mixed results: the Dow lost 2.2%, the S&P 500 finished lower by 0.7%, but the Nasdaq gained 5.7%. Over the holiday-shortened week, the S&P 500 lost 0.41%, the Dow fell by 0.72% and the Nasdaq dropped 0.81%.

For the bulls, it was another challenging week with the three major indexes again closing near their lows for the week. While the markets closed the year little changed, as Cabot’s VP of Investments Mike Cintolo points out, “historically, the years following flat market years (defined by a total S&P 500 return of between -5% and +5% for the year), the market averaged a gain of 23% the following year, with 90% of the years showing gains.” Also last week, Consumer Confidence and home prices rose, and oil, while volatile, did not lose significant ground.   

For the bears, the feared Santa Claus rally never happened; the S&P 500 lost 1.8% for the month of December. Also, likely in reaction to the Federal Reserve raising its benchmark lending rate, U.S. mortgage rates rose above 4% for the first time in nearly five months, and ISM Manufacturing data fell to a six and a half year low. Also, the Emerging Markets (EEM) continue to flounder, and former leading stock Apple fell for the fourth day in the last five and closed the year lower by 4.5%.

Volatility


The Chicago Board of Options Exchange Volatility Index (VIX) closed the week at 18.21—higher by 15.69%. I had expected option premiums and the VIX would be sold aggressively into the long holiday weekend, but with the market selloff on Thursday afternoon and terrorism rumors circulating into New Year’s, put buyers remained aggressive.

Events for the Week to Come


The release of economic data, which had been light over the last two weeks, will be very heavy this week. Leading the headlines will likely be Friday’s release of the December Jobs Report. Traders will also be playing close attention to oil, manufacturing and chain-store sales data.

Also this week, traders will be interested in which sectors “hot money” will rotate into early in the new year. However, I wouldn’t rush to chase fast money into sectors such as oil or retail. I would likely need a week or two of such activity before chasing into these sectors.

What Traders are Saying


Early last week, I highlighted the Short Straddle options strategy because I had a hunch that the market would close virtually unchanged on the year. To recap, a short straddle is a strategy that expects little movement and to capitalize on this, a trader would sell a call and put on the same strike. Because I had a hunch that the SPY would close the week around 205, we theoretically sold the 205 Call and Put that expired last Thursday for a net credit of $2.50.

So how did the theoretical trade work out? My hunch of little volatility worked, as the SPY moved 0.7% lower on the week—though not exactly at the 205 strike. With the SPY closing at 203.87, the 205 Calls we theoretically sold for $1.25 expired worthless for full profit. The 205 Puts, which we theoretically sold for $1.25, closed at $1.13 for a gain of $0.12. Net, the trade would have been a profit of $1.37 per straddle sold.

So though the trade would have been a nice winner, I did not have a great deal of conviction in my hunch and the risk/reward was not favorable. However, I did want to use the scenario as a teaching moment on a new strategy.


This is an excerpt from Cabot Options Trader, which features the most profitable investment strategies in any market. It’s your guide to quick profits using puts, calls, spreads, straddles, iron condors and other options trades. Analyst Jacob Mintz explains and recommends diverse investing strategies for big gains with controlled risk.

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