Barron\'s - 02.09.2019

September 2, 2019 BARRON’S M7

The Striking Price

Options

Roiled Times Call for This Option

By Steven M. Sears

ALL HAIL VIX $20 CALLS.

Withthenear-termoutlookfortheS&P

500 index clouded by the risk of presiden-

tialtweets,potentialinterest-ratecuts,and

other factors that could whipsaw equity

prices, it’s no wonder this call option has

becomeincreasinglypopularwithinvestors.

IfthestockmarkettanksandtheCboe

VolatilityIndex,orVIX,surges,the$20call

could be a big money maker. Should the

marketrallyandVIXdeclinebecause,say,

interest rates are cut or the trade war is

settled,thecallsdon’tcostthatmuch,soit’s

not a really big deal.

“The 20 strike is a nice option to hold

whenthevolatilityofVIXislowbecauseit

willmaintainitsvalueforsometime,”said

JakeWeinig,apartnerinMalachiteCapital

Partners, a volatility hedge fund.

Part of the allure of the VIX $20 call is

thatitrestsabovetheVIX’slong-termaver-

age level of about 19, a significant bench-

markforinvestors.TheVIXisaproxyfor

investorsentimenttowardstocksintheU.S.

andabroad;ifitistoofarbeloworabove19,

investorsfretthatthemarketisoutoftouch

with reality, and they trade accordingly.

VIX is now bouncing around 17 to 20,

andinvestorsareincreasinglybuyingVIX

callstoplaythestockmarket’snextmove.

WehesitatetofocusonVIXoptionslest

we perpetuate the false idea that it’s easy

touseVIXcallstomakedirectionalbetson

volatilityandstocks.Inreality,VIXtrading

is nuanced. Many investors harm them-

selvesbyheedingerroneousadvicetosim-

ply check out the level of VIX, buy calls,

and wait for the volatility index to spike.

Too few investors know that VIX op-

tions are priced off VIX futures, and that

the VIX is a tracking index that can’t be

traded.

Still,anactivecottageindustryexiststo

interpretVIXoptionstradesassignsofdi-

rectionalbets.VIXderivativesareusually

partofcomplicatedhedgingstrategies,es-

pecially among high-yield bond managers,

althoughitistruethatsomeinvestorstacti-

cally complement strategic hedges with

VIX calls to manage equity risk, particu-

larly in an erratic stock market.

Unliketraditionalportfoliohedges,such

as S&P 500 options, VIX calls don’t suffer

from “strike drift.” If the S&P 500 rallies,

S&P500putslosesomeeffectiveness.But

VIX strikes are “sticky.” At any time, a

VIXcallcanincreaseinvalue,especiallyif

thestockmarkettanks.Thestickyquality

hasrecentlyprovedpopular,overshadowing

concerns about structural problems in the

VIX market.

In February 2018, VIX surged 115%,

and the S&P 500 dropped 4% in one day.

Thesharpmovewastriggeredbysomelev-

eraged VIX products, and it chilled the

VIX market. Investors backed away be-

cause they thought VIX’s market was

flawed, but they are returning.

Should VIX’s qualities intrigueyou—but

not enough to trade VIX calls—consider

Cboe Global Markets, which exclusively

listsandtradesVIXderivatives.Werecom-

mended Cboe’s stock (ticker: CBOE), and

other major exchanges, in late May as a

waytoprofitfromrisinganxietyaboutthe

stock market’s future. At the time, Cboe’s

stock was up some 8% for the year. Now,

thestockisup23%reflectinghighertrad-

ingvolumesandanincreasedawarenessof

VIX’s powers.

In May, we told investors to buy Cboe

stock, or December upside calls. We simi-

larly recommended CME Group (CME),

Intercontinental Exchange (ICE), and

Nasdaq (NDAQ).Nowisagoodtimetore-

view profits in December calls, if you

boughtthem.Thestockpositionsshouldbe

maintained.

To initiate new positions on Cboe, or

other exchange stocks that have since

surged, sell puts that expire anytime be-

tween now and October. Pick strikes just

belowthestockprice.Thesetradesexpress

a view that volatility in the options and

stockmarketissomethingtoembrace,es-

pecially during a time of political and eco-

nomicuncertaintythatwillintriguehistori-

ansinthefutureperhapsevenmorethanit

is roiling present-day investors.

Equity Options

CBOE VOLATILITY INDEX

VIX Close VIX Futures

10

15

20

25

30

35

40

ONDJFMAMJJA

Daily Values Source: CBOE

THE EQUITY-ONLY PUT-CALL RATIO

Put-Call Ratio S&P 500 Index

55

90

125

160

195

230

265

SO NDJ FMAM J J A

Source: McMillan Analysis Corp.

SPX SKEW

Implied volatility %

7

8

9

10

11

12

13%

SO NDJ FMAM J J A

Source: Credit Suisse Equity Derivatives Strategy

NDX SKEW

Implied volatility %

8

9

10

11

12%

SO NDJ FMAM J J A

Source: Credit Suisse Equity Derivatives Strategy

Skew indicates whether the options market expects a stock-market advance or decline. It measures the difference

between the implied volatility of puts and calls that are 10% out of the money and expire in three months. Higher

readings are bearish.

Week'sMostActive

Company Symbol TotVol Calls Puts AvgTotVol IV%ile Ratio

Tilly's TLYS 3543 2356 1187 288 50 12.3

Ollie's Bargain Outlet OLLI 40865 23640 17225 4220 94 9.7

Tocagen TOCA 9879 9354 525 1088 97 9.1

GMS GMS 2201 1489 712 252 87 8.7

Zogenix ZGNX 33377 27413 5964 4000 8 8.3

Bilibili BILI 44809 34177 10632 6708 8 6.7

Trinseo TSE 2490 1745 745 400 90 6.2

Bitauto BITA 10610 9957 653 1748 97 6.1

J. M. Smucker SJM 17238 7336 9902 2980 60 5.8

Momo Inc. MOMO 124435 49944 74491 22676 38 5.5

Lannett Inc. LCI 32809 16590 16219 6224 62 5.3

Altria MO 603613 447230 156383 114664 94 5.3

Philip Morris PM 226312 125374 100938 44512 91 5.1

Cimarex XEC 31697 26781 4916 6164 99 5.1

Alexco Resource AXU 6954 6352 602 1420 75 4.9

H&R Block HRB 17521 9806 7715 3564 3 4.9

The Medicines Company MDCO 48489 20642 27847 9984 89 4.9

Anaplan PLAN 29246 19175 10071 6692 2 4.4

Autodesk ADSK 187728 84604 103124 43724 30 4.3

Guess? GES 25687 17317 8370 5948 66 4.3

Thistableofthemostactiveoptionsthisweek,ascomparedto average weeklyactivity–notjustrawvolume.Theideaisthatthe

unusuallyheavytradingintheseoptionsmightbeapredictorofcorporateactivity–takeovers,earningssurprises,earningspre-

announcements,biotechFDAhearingsordrugtrialresultannouncements,andsoforth.Dividendarbitragehasbeeneliminated.In

short,thislistattemptstoidentifywhereheavyspeculationistakingplace. Theseoptionsarelikelytobeexpensiveincomparisonto

theirusualpricinglevels.Furthermore,manyofthesesituationsmayberumor-driven.Mostrumorsdonotprovetobetrue,soone

shouldbeawareoftheseincreasedrisksiftradinginthesenames

RatioistheTotVoldividedbyAvgTotVol.IV%ileishowexpensivetheoptionsareonascalefrom0to100.

Source:McMillanAnalysis