Options Market Update March 21, 2016

 
The three major indexes continued their upward trajectory last week as the S&P 500 gained over 1% for the fifth consecutive week. For the week, the S&P 500 gained 1.48%, the Dow added 2.15% and the Nasdaq advanced by 1.14%.

For the bulls, it was another strong week as the S&P 500 is now back to unchanged on the year after suffering big losses in January and February. Aiding the rally this week was the Federal Reserve, which lowered its expectations for rate hikes this year, stability in the oil market and better-than-expected retail sales, housing starts and jobless claims.

For the bears, it was another challenging week, as the recent market rally has now brought the market back within a couple percent of all-time highs. However, the bears might point out that the rally continues to be led by “trash” stocks, not by traditional market leaders. Also, the central bankers’ easing policies are not delivering the global growth that they had projected, and the VIX is again at levels that have signaled too much complacency regarding risk in the past.

Volatility


The Chicago Board of Options Exchange Volatility Index (VIX) closed the week at 14, lower by 15% for the week. This was not particularly surprising after the market raced higher following the Federal Reserve’s announcement on interest rates. Also, playing into the VIX’s fall, this week will be holiday-shortened due to Good Friday. As I noted last week, I would be very cautious buying too many options this week, as the decay of the upcoming long weekend will likely hurt long calls/puts unless stocks or indexes makes a big move.  

Events for the Week to Come


Note that the market will be closed on Friday for Good Friday.

The week will be fairly quiet in terms of economic data releases. The most important event will be the release of GDP on Friday, when the market is closed. However, following the Federal Reserve’s announcement regarding interest rates last Wednesday, the market will turn its attention to five Fed members’ speeches this week, which should give the market more insight on the debate regarding interest rate hikes.  

What Traders are Saying

As I was scanning the market at the end of last week, I was somewhat shocked at just how cheap puts and market insurance had become. It was as if traders had already forgotten the market’s dramatic fall just weeks before.

It is somewhat similar to my personal situation. A couple of years ago, I had a horrible experience with kidney stones. The pain was excruciating and I swore that I would do everything in my power to never put myself in that situation again. And for a couple weeks, I stuck to a very strict diet. But as time passed, I forgot about the pain and resumed not eating healthy enough and not drinking enough water. Last weekend, I again suffered excruciating kidney stone pain, and again I swore that I’d never allow it to happen again.

With the VIX back at 14, it’s as if traders have forgotten the pain of the recent market plunges. Just weeks ago, traders were racing to buy puts as many portfolios were down 10%-20% and the pain was extreme. Fast-forward to today, and traders seem to have forgotten about the pain and no one wants to own protection.

While I am not calling for the market to again fall dramatically, with puts at these depressed levels, it makes sense to hedge long stock positions. For example, Bank of America traded as low as 11 one month ago. Today, the stock has regained 2.75 and is back at 13.75—if a trader was long the stock, he could buy the May 13 Puts for $0.35 to hedge against another painful fall. 


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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