Betting on A Volatile Finish to the Year

Patrick Ceresna
June 1, 2016
4 minutes read
Betting on A Volatile Finish to the Year

There has been no shortage of volatility in the Canadian stock markets over that last year. It was April of 2015 that saw the S&P/TSX60 top at the 905.00 level and usher in a 9-month bear market decline that wiped out 25% of the value of the TSX down to the 680.00 level in January 2016. Over the last 4 months, the S&P/TSX60 has materially bounced back, currently trading back to the 820.00 level.

Many are now asking – Is the bear market over?

One can easily write a 1000-word article on the topic and only scratch the surface of the debate, but we will summarize it as follows:

  1. Do you believe the global growth story has turned positive?
  2. Do you believe that commodity prices have broadly turned bullish?
  3. Do you believe that the core issues in the Canadian economy have been resolved?

My question – why corner yourself to having to pick an opinion when you can implement an options strategy that can profit, regardless of the direction. Let’s discuss how:

The Long Strangle Strategy

The strategy involves you anticipating that there is a big move coming in the market, but you are uncertain as to if it will be higher or lower. It involves buying a call option and simultaneously buying a put option. These options often have the same expiration and typically are both “out-of-the-money”. In addition, because you are the buyer of both options, it is ideal for the implied volatility of the market to be at the lower end of its range. This minimizes the Vega risk, and can have sudden spikes in volatility work in your favor.

Example of a Long Strangle using the XIU

The XIU is the iShares S&P/TSX60 Index ETF, which strives to replicate the performance of the Canadian market.

  • April 2015, the XIU traded to a high of $22.78
  • January 2016, the XIU traded to a low of $17.07
  • Our investor believes that by the end of the year the market will either make an all time new high, or reverse and break down to $17.00 or lower

The option strategy:

  • The XIU closed on May 31st at $20.72
  • Buy the December $21.50 call option – asking $0.30
  • Buy the December $19.00 put option – asking $0.52

Investor outlays $0.82 net cost for the combination which equates to $82.00 for every 100 share combination the investor wishes to control.

The added bonus is that the current level on the VIXC (S&P/TSX60 Volatility Index) of 13.71 is near the bottom of its range (note the blue chart below). This suggests that if a sharp move in the market spikes volatility, both the call and put option would increase further in value, enhancing the returns. As an example, if the VIXC just returned to the 30 level it traded at in February, the options could double in price solely from the Vega effect.

In summary, in periods where there is directional uncertainty, but the potential for big moves, the strangle is a valuable strategy available to traders.

Patrick Ceresna
Patrick Ceresna http://www.bigpicturetrading.com

Derivatives Market Specialist

Big Picture Trading Inc.

Patrick Ceresna is the founder and Chief Derivative Market Strategist at Big Picture Trading and the co-host of both the MacroVoices and the Market Huddle podcasts. Patrick is a Chartered Market Technician, Derivative Market Specialist and Canadian Investment Manager by designation. In addition to his role at Big Picture Trading, Patrick is an instructor on derivatives for the TMX Montreal Exchange, educating investors and investment professionals across Canada about the many valuable uses of options in their investment portfolios.. Patrick specializes in analyzing the global macro market conditions and translating them into actionable investment and trading opportunities. With his specialization in technical analysis, he bridges important macro themes to produce actionable trade ideas. With his expertise in options trading, he seeks to create asymmetric opportunities that leverage returns, while managing/defining risk and or generating consistent enhanced income. Patrick has designed and actively teaches Big Picture Trading's Technical, Options, Trading and Macro Masters Programs while providing the content for the members in regards to daily live market analytic webinars, alert services and model portfolios.

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