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Buy the Rally? US Index ETF Volatility Dropping Into Weekend

Jun 07, 2019

 

Diverse Option Strategies for All Risk LevelsDiverse Option Strategies for All Risk Levels
Diverse Option Strategies for All Risk LevelsDiverse Option Strategies for All Risk Levels

 

  • Heading into the weekend the rebound in US stocks has dampened overall volatility levels for the major US index ETFs
  • Of the universe we examine, options for the SPDR S&P 500 ETF Trust (SPY), iShares Core S&P Total US Stock Market ETF (ITOT) and Invesco QQQ Trust (QQQ) are the most expensive on a relative basis
    • Keep in mind that we are looking at the implied risk premiums of options for these ETFs where the 3-month implied risk premium is rich
      • Important to note that 1-month risk premiums are actually cheap
        • SPY is AI Smart Beta Rating CAUTION and AI Trading Signal SELL
        • ITOT is AI Smart Beta Rating CAUTION and AI Trading Signal SELL
        • QQQ is AI Smart Beta Rating POOR and AI Trading Signal SELL

 

  • Now what does it mean if 1-month risk premium are so low relative to 3-month?  It is actually not a very complicated issue.  Let’s break it down into parts
    • The further you extend the time to expiration, the greater the risk of time on the uncertainty of finishing in-the-money
    • Realized volatility over the past 3-months has been very high with the  impact of “volatility’s memory” much stickier

 

Your takeaway: given the recent volatility in markets over the past month, it would make sense that the risk premiums for longer dated options are higher than shorter dated

 

  • There are some cheap options as well.  Notably, the options for the iShares Russell 2000 ETF (IWM) and the iShares Core S&P Mid-Cap ETF (IJH) are relatively inexpensive
  • While implied volatility percentile ranking is above fair value, implied risk premiums for both 1-momnth and 3-month options are notably cheap
    • This is not counter-intuitive to us since our Quantamize models continue to favor owning small and mid-cap ETFs right now.  Maybe the options market is telling us something?!
      • IWM is AI Smart Beta Rating BEST and AI Trading Signal SELL
      • IJH is AI Smart Beta Rating CAUTION and AI Trading Signal BUY

 

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