After a six-month hiatus, the Chicago Board Options Exchange’s Volatility Index (CBOE:VIX) has dipped its toe back into the teens. The last time the VIX had a reading below 20 was on July 26, 2011.
Volatility expectations in general have declined by 34% in just over a month as the S&P 500 is a full 13% higher from the November 2011 lows. Breaking through the 1,300 level serves as a psychological boost for the market as well.
Given the most recent run-up in the market, we would not be surprised to see a bit of a pullback and for the VIX to gyrate around 20, which coincides with the index’s historical median.
What the VIX is Telling Us Right Now
Over the past week, Stutland Volatility Group has noticed several option plays (some offensive, some defensive) that could shed some light on the markets going forward.
Last Friday, there was a very large put butterfly purchased in the VIX. (That’s when you sell two at-the-money puts, while you also buy one in-the-money put and buy one out-of-the-money put. It’s a strategy for when you’re bearish on volatility but otherwise neutral about market direction.)
The initiator purchased 40,000 June 16/20/24 put butterflies for a $1 debit. This would appear to be an offensive options play with the expectation that the VIX is going to continue to trade at or around the 20 level as we move into the summer. If the VIX were to settle at 20 at June expiration, the spread would be worth $4.
Last week we saw several large buyers of VIX options, particularly of the Feb 30 and 35 calls. On first inspection, some might interpret this as bearish … and it very well could be.
However, these calls are significantly out-of-the-money and February is the front month; therefore, they only have 3-1/2 weeks to payoff. We view this as more of a “tail-risk” strategy.
These trades may be initiated to cover existing or newly implemented long exposure to the market. The initiators view could be that these calls are relatively cheap volatility exposure, thus worth the cost of owning them versus a long portfolio exposure to the market.
Another interesting trade initiated in the VIX this week was the purchase of March 22 Puts and April 28 Calls 67,000 times. Yes, they bought 67,000 March/April strangles for a price of $4.85. (Buying an out-of-the-money call and put with different expiration months sets up a wide berth of price and time where the trade can finish profitably.)
The initiator apparently is expecting a major move in the VIX or at least a major volatility pop in the VIX options.
Strategic Options Play: YHOO Buy-Write
Yahoo! Inc. (NASDAQ:YHOO) is due to report earnings tomorrow — Tuesday, Jan. 24. This stock has often been viewed as one of the crown jewels of the Internet, yet it has languished for the better part of the last decade while other Internet portals have seen tremendous growth in valuations.
Many feel YHOO focused too much on content, which has caused them fall behind technologically. Internal strife has also produced a drag on the performance of the company. There has been a great deal of tension between co-founder Jerry Yang, the board and past CEOs.
Earnings estimates have been lowered to $0.24 from $0.26 a year ago. Analysts also expect year-over-year revenue to decline to $1.20 billion this quarter, from $1.53 billion.
Yahoo! is a consensus “Hold” by most analysts. However, last week there was a major shift in the management structure at YHOO, as Yang resigned from all positions within the company.
After a lengthy “strategic review,” the board appointed Scott Thompson as CEO. This would indicate that Yahoo! will look to keep the company intact and move to use its strategic position to search for new methods of monetizing the exceptional traffic flow that it currently enjoys.
Technically, the stock appears well-positioned for further gains. The 50-day moving average (15.65) has crossed over the 200-day moving average (15.26). This indicates an increase in short-term momentum. Add to this a “flag” formation from the October spike (the flag pole) and the subsequent sideways motion (flag formation).
This pattern offers very strong upside support should YHOO breakout. A breach of $16.50 would signal further upside, possibly to the May highs of $18.50.
Given change in fundamental and the technical support, Stutland Volatility Group might look to Buy/Write this stock. For example, you could buy 100 shares of YHOO stock for $16.10 and sell one YHOO April 18 Call for $0.45. This trade would lower the breakeven on the stock purchase to $15.65.
Should YHOO break out to the upside and close above $18 on April 21, 2012, expiration, the maximum profit is $2.35, or a 14.6% realized return.
Here are the trade details.
STOCK PRICE: $16.10
OPTION PLAY: Buy-write
BUY / STOCK: 100 Shares $16.10
SELL / MONTH / STRIKE / PRICE: 1 April-2012 18 Call @ 45 cents
NET ENTRY: (45 cents x 100) = $45 credit
MAX GAIN: $2.35 (or 14.6% equivalent to STX) at or above $18 on April 21, 2012 expiration