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Market Overview
The news last week was all about the debt problems of several European countries along with the lousy U.S. jobs report on Friday. With all the headwinds it is amazing equities held up as well as they did.
Now it is time to take a more defensive posture. Here are two hedge ideas for options trading investors.
TRADE 1: TZA
The Direxion Small Cap Bear 3X Shares (NYSE: TZA) exchange-traded fund seeks daily results, before fees and expenses, of 300% of the inverse (or opposite) of the price performance of the Russell 2000 Index.
From our RT Options Scanner we discovered the unusual activity in this ETF on Friday with five strike prices trading more than 2,000 options contracts each while the call volume exceeded the put volume 6.6 times, as the Implied Volatility Index Mean was 58.81, up from 58.26 last week. The current Historical Volatility is 59.73 for an IV/HV ratio of .98. With good liquidity, Friday’s options volume was 31,534 contracts compared to the 5-day average of 31,400 contracts.
Here is a long call spread with good volatility edge for the upside direction along with a short put to reduce the cost.
| B/S | QTY | O/C | U Sym | Exp | Strike | P/C | Price | IV |
| B | 1 | O | TZA | Aug | 33 | Call | 1.98 | 61.07 |
| S | 1 | O | TZA | Aug | 37 | Call | 1.12 | 67.75 |
| S | 1 | O | TZA | Aug | 30 | Put | 1.72 | 57.59 |
| Cr | .86 |
The increasing price of TZA corresponds with the expected decrease in the price of the Russell 2000 Index. In the event the market turns higher once again use a close back below Thursdays low at 30.58 as the SU (stop/unwind).
Find more option analysis and trading ideas at Options Trading Strategies.
TRADE 2: XRT
The SPDR S&P Retail (NYSE: XRT) exchange-traded fund seeks to replicate the S&P Retail Select Industry index. Using the US employment report as the guide and having broken out to the upside with a gap last week, the retail sector could come under pressure.
The current Historical Volatility is 24.22 with an Implied Volatility Index Mean of 21.03 for an IV/HV ratio of .87 and an understandably high put-call ratio of 2.65 since it is used for retail sector hedging. Friday’s option volume was 15,230 contracts compared to the 5-day average of 27,620 contracts.
| B/S | Qty | O/C | U Sym | Exp | Strike | P/C | Price | IV |
| B | 1 | O | XRT | Aug | 54 | Put | .96 | 23.60 |
| S | 1 | O | XRT | Aug | 50 | Put | .29 | 28.03 |
| Dr | .67 |
At 17% of the distance between the strike prices this spread provides an attractive risk-reward ratio of almost five to one. Use a close back above 56.44 as the SU (stop/unwind).
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