Protecting the Flock
Analyzing the changing price of volatility and strategy implications
Setting the Table:
It’s been a rocky week for the markets as the macro economy and inflation drive the narrative. Despite what on paper looked to be good numbers from META and AMZN, their stocks were punished by the bears who ruled the tape. In the short term flows matter more than fundamentals.
Options activity picked up yesterday after what’s been a slow month. We see that OI has continued to trend down, but yesterday’s sell off printed almost 50 million contracts (10M in SPY) which was the highest figure in a month.
Two interesting tid-bits:
Jamie Dimon will be selling roughly 12% of his stake in $JPM starting next year. He’s planning the divestment for tax planning and diversification purposes. He’s accumulated roughly 8.6 million shares in his 18 year tenure at the helm of the company and could earn up to 2 million more depending on performance targets. His current stake is worth a cool $1.2B. No matter who you are, approaching retirement means derisking.
We talked about QQQY a few weeks back, and they’re coming up on month end. There’s a dividend announcement slated for Tuesday. They’re performing 1% point better than the NDQ index, but note the lagging performance on the upside. It’s counter intuitive being short puts, but choppy down markets don’t hurt as much as what you’re missing out on the upside.
When the market sells off we hear about protection strategies and when the market rallies we hear about endless opportunities. Bank of America bears are calling for another 5% drop in the market, and technicians are ringing alarm bells at the break of 4200.
The hardest thing about protection strategies is deciding how much they’re worth. The QQQY example shows the other side of the coin. Even with NDX selling off, the fact that QQQY about paced the market means those puts are pretty fairly priced.
If you’re paying with straight up cash, the next 90 days will cost about 3% of your portfolio in ATM puts for SPX. A full year is only 2.5% more at the 4150 level. If you’re thinking about a hedge consider that “ATM” a year out is closer to 4325 with a ~4% higher target because of a 5%+ risk free rate net against some expected dividends. Including that risk free return in your hedge calculation, pushes the price of ATM protection over 7%.
Implied volatility is the major driver of this pricing. At 90 days, we’ve seen the price of ATM volatility go from just under 12% to almost 18%.
Naively, we can say that ATM vol going from 12% to 18% is going to significantly increase the cost. Run the option through a pricing model only changing the implied volatility, and instead of the $131 we’d pay for that protection right now, at 12% implied vol it’s only worth $82.
Things have gotten expensive certainly, but are they extra-ordinarily expensive?
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