Room to Run?

SBUX, CSCO: Single Names in a Momentum Market

Setting the Table: 

• After two weeks on blender speed, volatility has taken a bit of a breather. It’s a quiet open, as speculative eyes focus on what nuggets pan out of Jackson Hole. 

• VRP at 10 days shows what a flash in the pan the vol spike on August 5th was.

  

  • Looking back 10 days on August 15th, we saw an implied vol of ~35% that was only followed by a realized vol in the 28% range. Both are very high for SPY, but it’s the differentials that are sitting at extremes also. 

  • Capturing this “VRP” isn’t a vanilla short vol trade. All of the movement since August 5th has been about delta, so a classic strangle/straddle/condor won’t work here. 

    • To make money on high vol, you want to sell directional vol. If IV comes in, it’s pretty likely the market is rallying. The magnitude is difficult to determine, so consider broken wing butterflies that give you a “run out.” Below is an example on the upside (at current SPY prices.) You can adjust the height (pnl) of that upside (and lower your best case) by taking more downside risk.

      

• The round trip has been dizzying. Momentum is a powerful force. It comes from crowded investor sentiment and time lag it takes to process fundamental information. Oh, I guess that wasn’t a big deal for the valuation of future cash flows on the 500 most significant American equities.

  • Technology has rapidly increased the speed at which the market can react to voting (see, Flash Crash) but the speed at which it can weigh more complex phase shifts isn’t improving as quickly. So we get a lot of head fakes.

  • Professional market participants must be nimble in price- that’s a bare minimum. They’re quick to get out of the way, and equally quick to jump on a reversion. The speed at which on goes to off creates pockets of dislocation that are a blip for longer term investors, but present meaningful opportunities for manual traders to capture favorable risk/reward structures. 

• Momentum trades work in multiple time dimensions. Short term traders can capitalize on the swoons and mispricings of emotionally driven markets. Medium and longer term traders can also use these signals to participate in trend following strategies. 

For our screens today, we’re going to be focused on comparing the differences between short, medium and long term momentum indicators. The sort is by the 50 day Bollinger level, and there are some interesting and high quality names at the top. 

You’ll recognize earnings and news releases drive much of the price action - as they should. The goal with options positions is to tailor a risk reward that matches your gut - locally and globally. 

Does the train keep on running with SBUX and CSCO? How much of the macro drift should you build into the thesis? If tightening happens erratically, it doesn’t matter what’s in the latte.