Where are the overlay vibes at?

Fifty Ways to Trade an Option

Every hot spot fades over time. As market cycles wax and wane, the most exciting event will never be the same.

Two years ago I was sneaking out in the middle of dinner to check what the latest CPI news had dropped on the market. Today, that’s a ho-hom bureaucratic event as far as volatility markets are pricing.

Before last week’s meeting Michael Hunt posted this exceptional set of charts. (Follow him.)

The below is the PnL from being long a straddle on CPI days. For the six years before CPI became a big deal, it had a choppy grind down. That theoretically jibes with what I’d expect from a simple long straddle, it will on average pay VRP to option writers.

Courtesy of VolVibes

Then when CPI days became the it thing, PnL explodes, bringing the strategy positive after years of bleed. Those movements decided what kind of bottle of wine to buy for the second half of dinner.

Moves have since slumped back down, and the strategy is back to bleeding PnL. SPX changes on CPI day have whimpered off.

Courtesy of VolVibes

If you’re looking for action, CPI is the wrong place. Alternatively, if you’re NOT looking for action, it might be the time to engage again. The prevailing wisdom of the last 2 years says I probably don’t want my condor bots firing. But I’ve been increasingly inclined to dip my feet back in.

The narrative has moved beyond inflation. We’ll still parse FOMC minutes and path very closely, but it’s not as significant of a volatility event. For opportunistic options traders, being aware of when that shift happens is very important.

It’s a perennial question - what type of market are we in? Is this the kind of environment where CPI straddles will blow out all expectations, or is this a snoozer? For individual stocks the broadest divisions here tends between a state of trend versus mean reversion. Knowing what the current state is can be highly informative for structuring your covered calls and overlays.

Today in Fifty Ways to Trade an Option, we’ll look at how to use the Hurst indicator to measure the dynamics of a specific underlying, and use that to calibrate an overlay position.

Are you interested in learning more about Hurst and playing with a calculation yourself? Reach out below and I’d be happy to share some code. I might even add it to TheTape.Report