Schaeffer's Trading Floor Blog

Reader Mail: Dissecting the VIX Drift

There are a number of factors that keep the VIX from lifting in a dramatic fashion

by 8/21/2014 8:03 AM
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Time to open up the (not terribly) voluminous viewer mailbag and answer some questions, some of which actually have to do with options.

And technically, it's not actually mail, or even email. These are just a few questions that I got asked on Twitter, which is a great way to ask questions, by the way. I'm @agwarner.


If VIX is a measure of put call buying why doesn't it go up on violent moves to the upside?

There's nothing to say it can't go up on violent upside moves, but we haven't seen that happen on any consistent basis since the late '90s tech bubble.

Remember that CBOE Volatility Index (VIX) measures implied volatility, which is part prediction of future volatility and part the price traders are willing to pay for portfolio insurance. A violent upside move pumps up realized volatility, and that does affect how the market prices implied volatility. But, the demand to protect portfolios generally decreases. No one's all that afraid of a super-fast move to the upside, plain and simple.

What's more, there's a natural headwind against VIX lifting in rallies. S&P 500 Index (SPX) options are skewed. The higher the strike, the lower the implied volatility. So, if SPX rallies, higher strikes with lower implied volatilities will comprise a larger part of the VIX calculation. Thus, VIX will dip on an SPX rally, even if the implied volatility of every individual option on the board stays the same.

On upward movements, it's often the drift that cause the problems (for premium sellers), not volatility.

OK, that's more statement than question. But, it's a statement I agree with.

Suppose SPX rallies 0.25% to 0.5% per day or so, without a range that extends much above or below that. That's going to come out to about an 8 volatility or so. If you can sell options at an implied volatility of 12, it sounds like a good deal, right? I mean, you theoretically will earn more in daily decay than you lose in price movement. And, it's so static that you probably won't bother to hedge your position much, if at all.

But here's the problem. Let's say you're short straddles or strangles. You're going to keep getting gradually shorter and shorter into rallies. In a day or two, it won't matter much, but eventually you're going to be just straight short -- and even though it's rallying very slowly, the net of the move cost you money.

Of course, you could take action at some point. The above assumes you just sell options premium and check back when the options expire. You could hedge your options' deltas every day, for example, and that would more or less lock in the advantage you generated by selling implied volatility at what turned into a good price vs. realized volatility.

Unfortunately, we don't know in advance what the market will do. If it has low volatility and just meanders in a range, you will cost yourself money with the constant hedging, Inaction was a better course.

It's always best when you sell implied vol. over whatever happens in realized vol. It's just not a guarantee of a winning trade.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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Among the stocks attracting attention from options traders lately are financial firm Bank of America Corp (NYSE:BAC), firearm issue Smith & Wesson Holding Corp (NASDAQ:SWHC), and alternative energy concern Trina Solar Limited (ADR) (NYSE:TSL). Below, we'll break down how option buyers are positioning themselves, and how much speculators are willing to pay for their bets on BAC, SWHC, and TSL.

  • BAC has spent the past few months trading between $15 and $16, and yesterday, the equity settled squarely in the middle of this range, at $15.52. Option traders are keeping the faith, though, per the stock's 10-day International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) call/put volume ratio of 5.54, which ranks in the 86th percentile of its annual range. Simply stated, calls have been bought to open over puts at an accelerated clip in recent weeks. Currently, premium on BAC's front-month options is lingering near historically low levels, as evidenced by the equity's Schaeffer's Volatility Index (SVI) of 17%, which ranks lower than 88% of similar readings taken in the past year. In today's session, Wall Street will be awaiting confirmation of Bank of America Corp's record $17 billion settlement for its role in the 2008 financial crisis.

  • Put buyers have picked up the pace on SWHC, ahead of next Tuesday evening's fiscal first-quarter earnings report. At the ISE, CBOE, and PHLX, the stock's 10-day put/call volume ratio of 0.88 ranks in the bearishly skewed 80th annual percentile. This negative tone isn't too surprising, considering SWHC shed 8.7% the day after the company unveiled its fiscal fourth-quarter results in June. Despite the uncertainty surrounding this scheduled event, front-month SWHC options are pricing in relatively low volatility expectations for the stock. Specifically, the security's SVI of 43% ranks lower than 64% of comparable readings taken in the previous 12 months. On Wednesday, Smith & Wesson Holding Corp settled at $13.19, and now sits 2.2% lower on a year-to-date basis.

  • Also stepping up to the earnings plate next Tuesday is TSL, with results due out ahead of the open. The company handily beat bottom-line estimates in late May, sending the shares nearly 31% higher in the subsequent session. Option traders are hoping for more of the same, per the security's 10-day ISE/CBOE/PHLX call/put volume ratio of 11.72, which ranks just 11 percentage points from an annual bullish peak. With 22.6% of the stock's float sold short, though, a portion of this call buying could be a result of shorts hedging their bearish bets against another earnings-induced surge. Regardless, now is an opportune time to scoop up front-month Trina Solar Limited (ADR) options at a relative bargain -- the equity's SVI of 61% ranks in the 13th percentile of its annual range. Shares of TSL finished at $13.15 on Wednesday -- notching their second consecutive close north of $13 for the first time since June 2.

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Analyst Update: Illumina, Inc., Lowe's Companies, and Marriott International Inc

Analysts offered their two cents on ILMN, LOW, and MAR

by 8/20/2014 1:56 PM
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U.S. stocks are modestly higher this afternoon, as Wall Street awaits the latest Federal Open Market Committee (FOMC) meeting minutes. Meanwhile, among the equities in focus are molecular diagnostics concern Illumina, Inc. (NASDAQ:ILMN), home improvement retailer Lowe's Companies, Inc. (NYSE:LOW), and hotel chain Marriott International Inc (NASDAQ:MAR), which have all attracted analyst attention.

  • ILMN is up 2% at $173.89, after Wedbush upgraded the stock to "outperform" from "neutral," and hiked its price target to $200 from $165. The new target implies expected upside of 15% from Illumina, Inc.'s current perch, and stands in uncharted territory for the shares. On the charts, ILMN has soared more than 57% in 2014, yet eight out of 18 analysts maintain tepid "hold" opinions, leaving the door open for additional upgrades to lure more buyers.

  • After plunging out of the gate, the shares of LOW have clawed their way to a fractional gain, with the stock last seen at $51.65. The stock initially retreated in the wake of Lowe's Companies, Inc.'s downwardly revised sales guidance, but traders appear to have adopted the glass-half-full approach, after CEO Robert Niblock waxed optimistic on spending heading into the holidays. Meanwhile, Canaccord Genuity increased its price target on LOW to $40 from $37 -- though the new target still represents a steep discount to the stock's current price -- and underscored its "sell" suggestion.

  • Finally, MAR has added 0.5% to wink at $68.50, and earlier notched a fresh all-time high of $68.53, thanks to a price-target hike to $68 from $64 at Morgan Stanley. The equity has advanced nearly 39% year-to-date, yet Wall Street remains skeptical. Nine out of 20 analysts maintain "hold" or "sell" opinions, and short interest represents more than a week's worth of pent-up buying demand, at Marriott International Inc's average pace of trading. Plus, option buyers have been picking up MAR puts over calls at an annual-high clip, as the stock's 10-day put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) sits at a 52-week peak of 11.53. A flood of upgrades, a short-squeeze situation, or a mass exodus of option bears could usher MAR even higher.

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Stocks On the Move: The Hain Celestial Group, Inc., Amicus Therapeutics, Inc., and American Eagle Outfitters

HAIN, FOLD, and AEO are moving sharply in Wednesday's trading

by 8/20/2014 12:58 PM
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Markets are trading modestly higher ahead of this afternoon's release of the Federal Open Market Committee's (FOMC) latest meeting minutes. Among specific equities, however, three of the day's biggest market movers are organic food issue The Hain Celestial Group, Inc. (NASDAQ:HAIN), biopharmaceutical firm Amicus Therapeutics, Inc. (NASDAQ:FOLD), and retailer American Eagle Outfitters (NYSE:AEO). Here's a quick roundup of how HAIN, FOLD, and AEO are performing on the charts so far.

  • HAIN is up 10.9% today to trade at $96.36, as a record showing in the earnings confessional overshadows a nut butter recall. Ahead of today's bull gap, the stock was sitting on a 4.2% year-to-date loss, yet HAIN's 10-day International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) call/put volume ratio of 3.15 -- in the 78th annual percentile -- indicates a preference for long calls over long puts in recent weeks. With a healthy 7.4% of the equity's float sold short, though, a portion of this activity may have been a result of shorts hedging against any earnings-induced upside. At present, it would take more than seven sessions to cover these shorted shares, at the security's average daily pace of trading, meaning if The Hain Celestial Group, Inc. continues its run up the charts, there is plenty of room for a short-covering rally to ensue.

  • Positive late-stage drug trial results and a pair of price-target hikes from Cowen and Company (to $14 from $9) and Leerink (to $9 from $6) have sent shares of FOLD nearly 30% higher today. At last check, the equity was lingering near $5.94, after earlier tagging a fresh 52-week peak of $5.99. Today's upward trajectory is just more of the same for Amicus Therapeutics, Inc., which is up 153% in 2014, so it's not surprising to see sentiment tilted toward the bullish side. All three covering analysts maintain a "strong buy" recommendation toward the stock, and, although short interest accounts for 24% of the equity's available float, it would take less than one session to cover, at FOLD's average pace of trading.

  • Jefferies this morning raised its price-target on AEO to $20 from $17 and reiterated its "buy" rating, after the company posted a better-than-expected second-quarter earnings report. Against this backdrop, the stock has rallied more than 8%, and is lingering near levels not seen since April. Additional bullish brokerage notes could be on the horizon, should American Eagle Outfitters maintain this momentum. No fewer than 75% of covering analysts maintain a "hold" or worse suggestion toward the stock, and the consensus 12-month price target of $11.98 stands at a discount to the security's current perch at $12.56.

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Analyst Downgrades: DreamWorks Animation SKG, Inc., Real Goods Solar, Inc., and Youku Tudou Inc (ADR)

Analysts downwardly revised their ratings on DWA, RGSE, and YOKU

by 8/20/2014 9:22 AM
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Analysts are weighing in today on film firm DreamWorks Animation SKG, Inc. (NASDAQ:DWA), alternative energy concern Real Goods Solar, Inc. (NASDAQ:RGSE), and China-based Internet issue Youku Tudou Inc (ADR) (NYSE:YOKU). Here's a quick roundup of today's bearish brokerage notes on DWA, RGSE, and YOKU.

  • Janney cut its fair value target on DWA to $27 from $29 this morning, but maintained its "buy" rating on the stock. The shares have advanced 6.4% so far this week, settling Tuesday at $21.93, after DreamWorks Animation SKG, Inc. named a new chief financial officer. However, the security has run into a wall in the form of its 10-week moving average, which -- along with its 20-week cohort -- has ushered DWA 38.2% lower in 2014. Against this backdrop, it's no surprise to find most analysts in the bears' corner, as DWA boasts just one "strong buy" opinion, compared to six "holds" and two "sell" or worse ratings.

  • RGSE is bracing for a 15% plunge out of the gate, as speculators and analysts pan the company's steeper-than-expected per-share loss for the second quarter. Canaccord Genuity trimmed its price target by $1 to $3, and Cowen and Company reduced its price target to $2.50 from $2.60. Roth Capital made the most dramatic move, slashing its price target to $1.85 from $6, and downgrading RGSE to "neutral" from "buy." On the charts, Real Goods Solar, Inc. has surrendered 26.5% in 2014, and finished at $2.22 on Tuesday.

  • Finally, YOKU -- which closed at $21.52 on Tuesday -- is headed for a 7% drop at the open, after the firm reported weaker-than-expected second-quarter earnings, and offered lackluster current-quarter sales guidance. As such, Brean Capital reduced its price target on the shares to $24 from $27, but maintained a "buy" recommendation. More negative analyst notes could be on the way for Youku Tudou Inc (ADR), as four out of seven brokerage firms maintain "strong buy" opinions. A round of downgrades could exacerbate YOKU's year-to-date loss of nearly 29%.

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