The shares of streaming giant Roku Inc (NASDAQ:ROKU) faltered after their June rally to the $460 area, dipping lower on July 1 despite stringing together 10 consecutive daily wins prior to that tumble. The ascending 20-day moving average has since moved in as support, though, and the equity appears tto be attempting another run higher. At last check, ROKU was up 0.9% to trade at $435.19. 

Roku stock has also made an appearance on Schaeffer's Senior Quantitative Analyst Rocky White's list of stocks that have attracted the highest weekly options volume within the past two weeks, with new names added to the list highlighted in yellow. Specifically, 384,469 weekly calls and 179,230 weekly puts have been exchanged during this time. The most popular contract during that two-week period was the weekly 7/2 460-strike call. 

Analysts are overwhelmingly bullish towards the security, with 17 of the 20 in coverage calling ROKU a "buy" or better rating. Meanwhile, the 12-month consensus price target of $450.50 is a modest 3.6% premium to current levels, indicating price-target hikes could be on the horizon. 

Lastly, the security's Schaeffer's Volatility Scorecard (SVS) sits at a high 97 out of 100. This means ROKU has exceeded option traders' volatility expectations during the past year -- a boon for premium  buyers.

On the latest episode of the Schaeffer's Market Mashup podcast and the last episode of the year, Patrick brought in Scott Phillips, Lavaca Capital’s Founder and Chief Investment Officer and Matt Moran, Head of Index Insights at Cboe Global Markets. Patrick, Scott, and Matt chat about risk-on/risk-off environments in 2020 (1:30), "Greek" talk (10:20), and options strategies amid volatility spikes (16:02).

Transcript of Schaeffer's Market Mashup Podcast: December 17, 2020

Patrick: Ladies and gentlemen, welcome back to the Schaeffer's Market Mash up. This is possibly the last market mash up of 2020. Let's finish strong and get right to it. Volatility ever present and can change at the drop of a hat. So obviously we all remember early to mid-February, how we all felt about life in stocks and general, and then come March a month later, the S and P 500 lost a third of its value due to the pandemic. Today I'm joined by Scott Phillips Lavaca capital's founder and chief investment officer Scott, welcome. 

Scott Phillips: Thanks Patrick, good to be here. 

Patrick: And I also have Matt Moran head of Index Insights at CBOE global markets Matt, welcome. 

Matt Moran: Thank you, Patrick. 

Patrick: And today we're going to discuss how traders can use options as a tool to empower our inner Warren buffet, who has the famous quote of "it's to be fearful when others are greedy and greedy when others are fearful". I want to set the stage first by explaining the difference between a risk on and risk off environment to our listeners. And I know Matt and I were talking about this before we aired and 2020 is tricky. You know, the growth stocks were doing well while the value stocks underperformed, which is sort of the inverse of what the risk on and risk off environment implies. And then of course there's been rotations within the year. Matt, can you start to unpack that for our listeners just to start off?

Matt Moran: Sure. Well, if we're talking about the question of risk on versus risk off in 2020, it's not, maybe not quite as crystal clear as you might expect in that. Certainly if you're talking about risk on what I think about, I've been reading about risk on, you're talking about a situation where investors have an aggressive growth oriented feelings about the market. Whereas the risk off environment, you're talking more about more of fear in the market and more of a focus on safe havens. So what do we have this year? Well, you had a situation where the market early in the year was starting to go up, but then concerned about COVID basically hit worldwide. And by March you had a situation where the CBOE volatility index, ticker symbol VIX, very, very well known. It's all time daily closing high at 82 point 69.

That was in March, and certainly you could say, well, that's got to be a risk off environment. There's got to be, people have got to be fleeing for safe havens, but what you did see in subsequent months was people were looking at different sectors and different opportunities. And certainly different sectors, different industries out there did perform in very different ways and that energy was weighed down. But you did have some tech stocks and whatever, actually not, actually doing pretty well. And so you could say, well, it depends on what sector you're talking about, but certainly we did have, we have had an interesting year in terms of the risk on and risk off attitude on investors.

Patrick: its hyperbole sometimes to say it, but this year has been so crazy as far as what to expect. It's always worth breaking it down a little bit more. Scott, do you have anything to add?

Scott Phillips: Yeah, certainly. So, you know, to us, it just, it all comes down to investor expectations and what we're actually seeing price-wise in the various assets that trade globally. So, you know, Matt mentioned a bit to safe Haven assets. You know, typically a risk-off environment will be marked by something like that, where you have a bid to treasuries, a bid to those global government type securities particularly in the US. They kind of mark a traditional risk off environment you know, fast forward that towards more of the volatility side of things. And as Matt mentioned, you can see that present in the bit, right? So Matt mentioned the Volatility Index, the VIX and the S and P 500 and what that is particularly doing and how quickly that's changing.

And so you can look at a VIX of 85 as Matt mentioned, and certainly say that that would mark somewhat of a risk off environment. But high volatility doesn't necessarily, at least expressed in high VIX terms; it doesn't necessarily mean a risk off environment. So fast forward to the most recent month where by historical standards the VIX was still elevated in the period of November, but we had one of the strongest equity performances in quite a while. And so, you know, that pairing between what the volatility index is doing, what all the other asset classes are doing in terms of price movement that really helps define what a risk on or a risk off environment may be.

Patrick: Okay. That makes sense; I'll stick with you here. Is it as easy as considering a period of high volatility strictly when the VIX is above 20?

Scott Phillips: Yeah, that's a great question. You know, I would say if this was 2017, certainly a VIX of 20, would mark a higher volatility regime. And I think that you need to break it down by different time periods to kind of look into what high volatility, low volatility, average volatility really is within those different "volatility regime". So historically over the full Matt, what was it? 1990, 1992 that the VIX launched?

Matt Moran: The data on the VIX go back to January of 1990.

Scott Phillips: Right. So back to 1990, January, 1990, if you look over that full period, the VIX has averaged about 19. We've certainly had periods much lower than that, and much higher than that. The most recent March [unclear 06:22] the highest VIX level ever. And like I mentioned, 2017, I believe we had the lowest VIX reading ever in 2017. But historically has an average of around 19. And it has a range that it typically moves in of plus or minus eight points. So if you look at the standard deviation of the VIX movement, including all of these outlier events, which certainly skews some of the data the VIX typically moves plus, or minus eight points from that 20 point or that 20 or 19 average. 

And so when we think about, you know, what's a higher volatility regime, I think you got to dial in to the different time periods that you're looking at, because, you know, this year 20 is in the high VIX, right? That isn't necessarily a high volatility regime but in 2017, it may have been for that period. And then also look at that in the greater context of the overarching time period of that full history. And you can even utilize some of the S and P price movement and go back and extrapolate what the VIX would have been say on black Monday, right. Or what real life volatility would have been on black Monday back in 87, and really begin to get a better picture of what is considered "high volatility".

Patrick: Yeah, that's very helpful. Matt, do you want to expand on that?

Matt Moran: Yes. Well, you might say, well, high volatility, low volatility; VIX is above its long-term average. That's all nice, but how does this impact investors? And I would say this, that if you were in a higher volatility regime, let's say where VIX is around 30. Well, you have a situation where at least for some investors that might go to risk off where they might say, I'm going to look at safe Haven investments. Well, the challenge you have right now, though, is if you're looking at safe Haven investments like Treasuries, for example, the interest rates on those treasuries are extremely low. And you could say, well, actually, maybe that really isn't that safe and that if these interest rates are so low and there is the risk of the interest rates eventually going up. 

Maybe you could even lose money on these treasuries, but anyway, it's not a great place to be arguably. So what are the alternatives if VIX is high? Well, another thing to keep in mind though, if the VIX is high. If you were to go out and sell index option for example, there is the possibility of generating more options premium. And for example, at CBO, we do have several benchmark indexes and for example, we have the well-known DXM Bi-Rite index, and that goes out and sells one month option. Sells one month, 30 day at the money that's BX options and research does show that, for example, if you go out and write the options, when VIX is around 10, you're only generating about 1% per month, which comes out to about 12% for your gross premium. 

So that's pretty good but if the VIX is at 30, you generate about 3% per month 09:26  over 30% per year in gross premiums. Now, I do want to stress and talking just gross, not necessarily net, obviously the premiums you generate on an option writing strategy are all positive. It is possible, particularly in a bear market that your option writing position could actually take a drop. Anyway, the whole idea of generating more options premium with option selling strategies in times when VIX is high can be pretty appealing. And in my mind could be certainly considered by investors who are concerned about this low interest rate environment right now.

Patrick: I want to run with that a little bit and help me understand what is going on when volatility is rising. We know the price of an option is affected of course but there's more to it than that. And I'm thinking of the Greeks, which I've been in this business now for three years, and I'm only just starting to understand. So Scott, and then Matt unpack that a little bit more for me,

Scott Phillips: Certainly. Yeah, so there's different pricing components that make up the overall price that you see listed there on your screen when you're buying or your selling an option. Those are what's known as the Greeks and there are various first and second derivative Greeks that affect that option price. So go back to your calculus days a little bit here we first mentioned volatility being impactful to the overall pricing of an option and that's certainly true. That Greek is called Vega, and Vega is the amount that an option price will change based on a one point change in the underlying volatility of that instrument. So if an option has a Vega of 20 and the volatility rises at one, then you would have that corresponding change I should say 20% corresponding change to the overall option price.

So when we see periods of higher volatility, we get higher prices and options. When we see periods of lower volatility, we see lower prices and options. And so there's a direct impact by that amount of volatility change to the overall price. Other Greeks, that you may be familiar with the Delta Gamma and the life there's several others that I could go into, but those beta being kind of the fourth one, those four would be the four major. Just to break them down a bit more, we talked about Vega, Delta would be the change of an option for a change in the underlying price of the stock. So you're looking at S and P options Matt mentioned, a $1 change in an S and P option with a Delta of 30 would have a change to the option price of 30 cents.

Patrick: Okay. 

Scott Phillips: When we look at Gamma, Gamma is the change of Delta meaning that for every change that that market or that underlying instrument changes in price we reset the Delta to those different levels. And so I kind of liken it to driving down the road, so Delta is how fast you're going down the road while gamma is a Mount that you're changing, you're accelerating or decelerating as you're going down the road. I think that gives a pretty good depiction of how your Delta changes in respect to the option price and the underlying stock price. And then lastly would be Feta, Feta is the price, are the decay of an option price, and how that price, that option price will change as time passes. So Feta is the time passage component of the option price.

Patrick: Okay. Now my eyes kind of glazed over after you said, go back to your calculus days, but you brought me back with the driving analogy and that does make a little bit more sense to me. Matt, do you have anything to add?

Matt Moran: Yes, I'd like to pick up on just one of the concepts that's Scott mentioned feta or time decay and I'll put this in hopefully somewhat simple to understand language. When we came out with a BXM, Buy-Rite index early in this century, a lot of money managers at the time would write options just maybe once a quarter, right and write them four times a year. But then we came out with the BXM index with the whole concept. Well, how about writing more frequently? How about writing once a month? And the advantage of doing that running 12 one month options versus four, three month options is the fact that you are taking advantage of this option seller anyway, is taking advantage of time decay or Feta in that time decay or Feta helps the option seller, the closer you get to expiration.

So the thought is that roughly one should collect about twice as much premium writing 12 one month options as with four, three month options. Furthermore, in recent years, we've come out with weekly options. And certainly managers now are starting to look at that and looking at even shorter time periods. And so, for example, some managers actually do write options multiple times a month. I think some people sometimes suspect, oh, are they just doing that to speculate? No, they're doing it to take advantage of time decay or theta. And we now actually do have an index WPUT that does go and write in cells as PX options, 52 times a year. And the thought there in general is the fact that theory serious that, well, you write 52, 1 week options as opposed to 12 one month options. The goal there is to generate even twice as much premium as writing less frequently.

So anyway, the thought is that if you go out and write more often, that there is potential to generate more gross premium one morning though, is the fact that while you've really got to, you really should know what you're doing. Some people I think would say, well, you should maybe leave this to professional investors and certainly can invest in funds who are managers are able to access these concepts and these goals. But anyway, Theta and time Decay certainly is a very interesting concept that more and more options sellers are taking a close look at with the idea of generating more options premiums. And we do have an index now, ticker symbol WPUT again, that writes SPX options once a week, 52 times a year.

Patrick: I want to pivot now over to options strategy does a market participant always have to change their strategy when volatility rises, what's a formula, or at least some basic guidelines that they should be following to stay in the game? Scott, you can take that one first and then Matt can finish up.

Scott Phillips: Yeah. I mean, different environments call for different structures, you know, to us at the end of the day; an investor has to form a thesis, right. And you have to have a thesis, and then you have to make a decision on that thesis, that's how you're going to express it, right. So if you think that a stock is going to go up you may look to purchase a co-option, right. Very similar, if you think that a stock is going to go down you may purchase a put option a as a way to express that thesis, but everything ties into having a core thesis and a way to express that thesis. What we like about options is that they give you multiple ways to express that thesis. So you can get creative in how you're looking to express that thesis, and you don't have to have just a linear type return profile to your, to the strategy that you're using.

So, you know, step back to March this year, you know, an investor may have looked at the time period in March as a really extraordinary time period. You know, determining that those 10% daily moves that we were looking at you know. I think we had one that was over 10% and I note several in the seven to 10% range that those types of moves just weren't sustainable, right? And maybe that investor had purchased a put option to protect their portfolio you know, maybe a month or two before that. Maybe, you know, back in January when COVID first started appearing on the scene yet the equity market continued to rise. They decided to purchase that put options to try to hedge their downside exposure and their equity portfolio at least. 

And so fast forward to the week of March 23rd, when the equity markets bottom that put options that that investor had purchased benefited two fold, one had benefited from the price decline. If they still, if they had a maturity that went through that period had benefited from the price decline. It also benefited from the expansion of volatility that we saw. So Matt mentioned that 85 VIX I believe, you know, ahead of this, we were at 13, 14 and the VIX all the way up to 85. So you had a very, very large increase, I think Matt correct me if I'm wrong, I think that was the sharpest rise in the shortest period of time in the VIX that we've seen since the nineties. So pretty extraordinary, pretty significant historically type of period that we experienced there. 

And an investor may have utilized that opportunity to protect, to perhaps monetize their hedges so the PUT they purchased, they could have been sold into that type of event. So I think when you're looking at the environments and you're looking at how different environments impact your strategies, it comes down to your thesis, right? If it's protective and nature, like we just walked there or maybe it's more yield in nature, like Matt just mentioned. So potentially looking to sell some type of option to generate a type of yield, this other strategies that people implement based on different regimes. And it all goes back to those volatility regimes that we've mentioned at the beginning of the, of our time together. Yeah. 

Patrick: Yeah, that makes sense. Matt, do you have anything to add, or do you want to kind of build on some other factors that you are considered for an option strategy?

Matt Moran: You know, I think your question was in regard to what do you do when options volatility, rises? And this is kind of a key point from my point of view, in that I believe a lot of investors out there are saying, well, I'm not going to put on protection unless until the market takes a big fall. Well, one of the challenges right away though, is the fact that, well, the market takes a big fall in general, and the VIX price is going to go up. And so the cost of your hedging could be quite a bit higher and so if we get back to the statement, you mentioned earlier, as far as Warren Buffett said, be fearful when others are greedy and greedy, when others are fearful. The problem with buying protection, when the market is going down is you're being fearful when others are being fearful too.

And that can be a little expensive. And so you do want to keep that principle in mind, you want to keep in mind what your goals are, and if your goal is long-term capital protection and avoiding big drawdowns. You might think about, well, maybe I want, you might want to put on some protection when the VIX actually isn't that, isn't near its all-time highs. And recently we did have a webinar featuring a major Midwestern endowment that said that, yes; they devote 2% of their allocation to hedging types of strategies. With the realization that the vast majority of the times, these hedges are not going to pay off, but the hope is, and years like 2008 and 2020 that the hedges really can pay off and can help smooth out returns. And so again, I'd say, keep that in mind and certainly when volatility rises, that does impact the implied volatility and it can impact both option buying and option selling strategies, Patrick.

Patrick: Okay, great. Well said, Scott, did you have anything you wanted to expand upon when you were talking about objectives and a little bit more about risk tolerance.

Scott Phillips: Yeah, certainly, you know, Matt brings up some good points here and, you know, by having that safety net so to say in the form of a PUT option potentially in the example that we're discussing now. It really allows an investor to manage their emotions, right. It's you know, when we were talking earlier, Patrick, you know, I mentioned kind of the seatbelt analogy and it really, you know, I really kind of liken it to getting in your car and putting on your seatbelt. You don't ever want that seatbelt to activate. You never want that to be the scenario but it's there just in case, right? And it can be a lifesaving type feature in your vehicle, safety feature in your vehicle, in the case of an impactful crash or, you know, God forbid something horrendous happening, right.

It can really be there to save your life, same thing of a PUT option and portfolio. You never want them to pay off, right. When somebody buys a PUT option, unless they're speculating, if they're using to hedge it, they don't want them to pay off, right. And all the best worlds the market goes up, yeah they lose the money that they spent on the footprint [unclear 22:41]. But their stocks went up in price, right. And so they essentially made money that way versus the market declining and that being really impactful on that drawdown being really impactful, not only to their financial state, but to their emotional state. 

So if you look you know, right now the price of the PUT option out in the four to five month range may run an investor 2 to 3% when using an out of the money option to protect the portfolio. Yes, that is a cost to their portfolio and will be a drag if the market goes straight up between now and that time period. But it's a safety net for them and it gives them some peace of mind. And just to kind of add to what Matt say, you know, you really want to look to hedge these positions or to utilize these when you get the cheap opportunities. And then potentially profit from them when things get a little bit dicier.

Patrick: Yeah, I love that seatbelt analogy. From a personal standpoint, I always liked wearing my seatbelt don't you want to enjoy a ride knowing that you are safe and secure. You, never get a better sleep than knowing that peace of mind. Just, it always made sense to me to have that insurance locked in. Another personal example completely out of that field, but I purchased PGA championship tickets for Kiawah Island back in November for May. And it said, do you want to buy, you know, insurance for these tickets because of the pandemic? I said, of course, you know, now I have no worries about, are they going to allow fans or not? And you know that peace of mind, I think, is very integral to an investing strategy, especially when it pertains to options. Scott and Matt, I want you both to give the best advice you've received when making capital allocation decisions. Scott, you can go first and Matt, you can wrap it up.

Scott Phillips: Yeah, I took the best advice that I've received is to always protect your downside you know, by managing your draw down risk. You know, we talked about the emotional toll that a significant draw down can have on an investor, managing that risk potentially through the use of options can really allow you to emotionally weather that market volatility when things inevitably go array, right. It does seem like more and more so over the past several years we've had more episodes not maybe to the extent of March. But we've certainly have had sell offs that have come by surprise to many investors or caught many investors by surprise. And it really gives you that ability to kind of stay invested you know, knowing that you have the, have that protection on you know, the well-known secret, I guess to being consistently profitable is really limiting your downside.

And to us, you know, as I kind of look at the world, that's exactly what a PUT option can offer. Certainly it has its own implementation challenges, right? That an investor needs to know what they're doing when utilizing these instruments just don't take me, don't, you know, don't take me wrong. Any of these instruments require a significant amount of investor education before utilizing them, but an investor. You know one of these tools at the hands of a well-educated skilled investor can be a highly, highly useful tool in their portfolios.

Patrick: Well said.

Matt Moran: Well, in conclusion, one of the things I'd like to point out is the fact that Warren buffet is going out and actually certainly looked at the idea of collecting premium. He's gone out and bought several insurance companies whose main business is to collect premium. Another thing he's done though, too, is to go out and sell long dated OTC index options is collected upfront premium of $4 billion. So the whole idea of going out there and selling options, collecting premium certainly has been strongly endorsed by Warren buffet of all people. And at CBO we have a lot of resources if you do want to look in this concept more, as far as selling options premium, taken advantage of that, taking it into some premium that can help smooth out returns, generate more income for you. 

We do have several resources. So the resources would include bench mark indexes, such as the BXM, and the BXMD Bi-Rite indexes, and also the PUT, PUT write index. So we've got these indexes out there also in 2020, the Wilshire analytics firm, a firm, which has 20 I'm sorry, 1 trillion in assets under advisement. That firm has actually published three different papers and the whole idea of going out there and selling richly priced options premium to help smooth out returns. Hopefully generate some good risk adjust to returns. So there is quite a bit of research out there to help you out when you do try to attack these ideas and try to get a better handle on how can I generate more premium in times of low interest rates. So thank you very much for the opportunity, Patrick this has been a great call today.

Patrick: Yeah, thanks Matt. I mean, that's outstanding I, honestly I wish we can. I have a thousand more questions for you guys, and I can run up two hour podcast here. Thanks again, both of you guys, Scott Phillips Lavaca Capital's founder and chief investment officer down in Houston, best of luck with those ailing sports franchises.

Scott Phillips: Had to get the plug in.

Patrick: Had to get one little, I forgot in the intro. So I was like, alright, make sure I get the jab in at the end. And then Matt Moran, head of Index Insights of CBOE global markets. Matt, I have no qualms with any Chicago teams, so you get off free today. 

Matt Moran: Okay, sounds good. 

Patrick: Thanks again, guys. Stay safe out there and hopefully we can maybe revisit this conversation down the road because like you guys have both said there is so much to talk about here and we're really only just getting started.

Scott Phillips: Right.

Matt Moran: Okay, thank you Patrick. 

Patrick: Thanks guys. 

Scott Phillips: Thanks Patrick thanks everyone. 

Patrick: Cheers.

On the latest episode of the Schaeffer's Market Mashup podcast, Patrick sits down with Schaeffer's Senior Quantitative Analyst Chris Prybal to talk his two recent GameStop (GME) options trades that netted 706% and 655% returns, respectively. Chris walks through what made GME an intriguing bullish pick (4:14), how options traders are impacted by it all (9:30), historical context and future ramifications (17:29), plus other sectors and industries that caught his eye for 2021 and beyond (21:50).

Transcript of Schaeffer's Market Mashup Podcast: January 28, 2021:

Patrick: Ladies and gentlemen, welcome back to the Schaeffer's Market Mash up. It has been a minute folks, little over a month last time I checked. Happy belated new year to everybody first of all and what a time to reconvene though, am I right? The past week on Wall Street has been one of the weirder in recent memories, and that's saying something. You've got Reddit folks banding together to take down hedge funds, Twitter personalities clashing left and right, stocks with zero technical prowess, soaring to unheard of levels. It's like one plus one equals three or down is up and up is down. I can't tell you how many texts I've gotten from people asking me because they know I work in the financial space. What on earth is going on? I don't really know either like I'm sorry I have no clue. I needed an expert to unpack all of this. So, without further ado, please welcome back Schaeffer's senior quantitative analyst, Chris Prybal to the podcast. Chris, what is happening, my man?

Chris Prybal: Thank you, Patrick. First off for having me back you've had an impressive list of guests here on the show. I mean, it really took me a while to go through all the podcasts because I wanted to scrape as many notes together because I was learning things each time. So, good job to Schaeffer's for bringing all these people together, good job to you for putting it together. This volatile market it really is a head-scratcher. We got a lot to talk about, Game Stop, man. Where do we begin on this? Where do we begin?

Patrick: I don't even know. 

Chris Prybal: Let me tell you a little story about Game Stop while we begin that kind of brings everything together. We're the longest of time; let's say going back to the all-time highs on Game Stop, 2013 until February of last year, 2020 Game Stop had fallen 95%. So when you hear these short sellers being upset or losing money, keep in mind that they have made a killing on Game Stop for quite a long time. Maybe they had made too much money on Game Stop because last year things fundamentally started to change on the company and from the media flow and the sentiment, it was unnoticed to a certain degree. There was a point last year Patrick, in 2020 GameStop had 6 billion in sales that had been followed and that's what people were arguing. 

However, the market cap of all of the Game Stop shares was only 300 million. So you've got a company that's going 6 billion in revenue, and it's only valued at 300 million. How many companies today would love to have 300 million in revenue, but they're valued at 6 billion? What was totally undervalued coming into 2021, short interest from the end of 2018 was only 15 million but then, by the beginning of this year, it had shot up to 71 million. If that's in the indication of how much shorting was going on, as GameStop was going down, I cannot make a fundamental case for why GameStop is trading at $350 up a hundred percent from yesterday's price. I will try to bring it together for you later in the pod, but I think that's a good place to stop as a lead into the first trade. I think we wanted to highlight, correct?

Patrick: Yeah. So you had two options trades to start, or at least to end 2020 heading into 2021. I'm looking here at our spreadsheet and I'm seeing your respective gains of 706% and 655%. So first things first, congratulations good buddy, because that is quite the haul. You started to allude to some of the drivers such as the short interest and the favorable market cap. What else led you to this bullish GME position?

Chris Prybal: RC ventures took a position late last year and this had been, this was a follow-up to an announcement the company had made where they were going to become a streaming partner with Microsoft. That was on October 8th of last year and the stock did gap up 20% and it had a good start. But once again, we're talking about when GameStop was in the teens, not 350, like it is now. So it has made a big move, but initially the sentiment against it was still so negative. I mean, you've seen the Barron's articles that are routed to the group, the [unclear 05:27] alpha articles. These were 2, 3, 4 weeks ago. 

You know, when GameStop was in tens and the twenties, you know, these people were bashing it like it's, blockbuster. You know [unclear 05:41] out of business, why would you want to own this company? And I started thinking about it every time I drive past to Game Stop; there are people outside the door. And I know there was that craze because of the release of the new gaming consoles, but it seemed to me that they had a lot of traffic. They have a lot of revenue; there is value in this company. You coupled that with the Microsoft partnership, who's decided Microsoft couldn't buy GameStop even at these levels and just make it an X-Box store and sell gaming platforms and accessories and items to the community, almost their bricks and mortar leg of the streaming platform.

You can connect both ways. So when you look at, you know that there are possibilities to the fundamentals, improving enough. Now, again, I think we've gotten out of control because it's worth like $20 billion right now. When I put on this trade, it was 3 billion. I look at esoteric indicators and all of them is a 1000 day moving average.

Patrick: Okay. So that comes out too.

Chris Prybal: Roughly a four year moving average.

Patrick: Four year moving average, okay.

Chris Prybal: [Unclear 07:02] 52 calendar days, trading days per year. 

Chris Prybal: It's a long-term moving average obviously, but GameStop had traded, had begun to trade into that level and then it broke above the level. So there was some technical signs that there was a sea change occurring. And when I put on that trade, the first one, it was after earnings and GameStop actually pulled back to that 1000 day after being above it, that also aligned with 100% year to date at that time in 2020.

Patrick: I remember that because everyone was saying, wow, you know, look at Game Stop here. This is pretty interesting.

Chris Prybal: At that time, short interest had exceeded the float, the outstanding float of, on the marketplace. There were more people, short Game Stop than there were publicly traded shares available, which that in and of itself is a head-scratcher. And I'm sure regulators are going to look into this because it is creating a huge panic right now, as we talk on many, many, many, many stocks. I just saw a headline on Bloomberg that Joe Biden's not looking into Game Stop. I always get his last name, incorrect, Paul Pate he made money on GameStop this week. And since he's looking at running for governor of California, he's already decided I'm going to donate those proceeds to charity.

Patrick: I've seen that go around a couple of times with people on Reddit.

Chris Prybal: There's just so much going on with Melvin capital needed additional funding because basically they were bailed out on their Game Stop losses. I mean, you got to ask your question, did they not see this coming in advance? In addition to RC ventures, which is Ryan Cohen ventures taken a position Sen vest also took a 5.6% passive stick. Ryan Cohen himself on December 15th, December 16th, while we were already into the first leg of his trade, he personally bought more shares. Why am I telling you this? Well, if you have short interest so high and the available float actually shrinks, instead of increases, those people are even more vulnerable. 

Those shorts, there's not enough shares to cover them all. Now you're going to ask me eventually how option trading played into this. And there is a combo effect, the rush by the Reddit crowd that the Discore Trout, Robin Hood traders, Stock Put you name it. When they were rushed in Game Stop, there was huge call volume created. Now you've had exchange brokers and agency brokers and all kinds of market people on this podcast. So I won't get into too much detail, but if I'm the market maker and you as the customer buy the call from me, I'm the market maker. I'm now a net short that call. So how do I hedge my position if I'm net short? I have to buy underlying shares, proportional to the call contracts I sold to you. 

So if there's a huge rush of option traders, demanding call contracts, the market makers go net short, but to heck is that they buy stock, by them buying the stock it pushes it up, which squeezes the shorts and then the shorts have to cover. And then you get hauled seven times in one day, then you get this after hours trading, you cannot blame the after-hours movement on the retail crowd. That's big money player’s right there, that's not the retail money doing that after hours.

Patrick: I think that is being glossed over in certain media outlets where they're just saying its being short squeezed out. You know, it's just Robin Hood traders, you know, just clicking on their accounts, sitting on the couch. You look at the technical it's not that it's the big markets that are making the moves.

Chris Prybal: It's the market makers trying to get a grasp of the situation. And that's why you're seeing implied volatilities on some of these contracts exceed 2000%, which I've never seen that if you get to 1000%, it's super rare. If you get to a 200 IV, it's really, really rare though, 2000 I mean, and that makes it very difficult on retail and any trader because right there in IV, you’re paying so much per contract, that it's almost not worth trading because you're going to have to get so much price movement off of that contract that you need such a fat tail distribution to get what you want done. So it's, the market makers are kind of shutting it down and they will continue to until we get some kind of regulation or some kind of answers or hedge funds blow up and then additional money comes in and that money is blowing up because they're still short. A lot of other companies that are going up 20, 30% in a day.

Patrick: Yeah, AMC.

Chris Prybal: They're taking a hit. These people are taking a hit and it might automatically drive down the overall market, which we need a breather, but it'll drive down the overall value because these companies now have to raise cash to cover their losses. Their best way to raise cash is to sell existing holdings that they have, that they're [unclear 12:35]. So if you have that selling pressure it's going to put a blanket over the rally.

Patrick: Yeah and what I find scary is I, you know, against better judgment, I perused Reddit earlier today and you have people saying, keep hammer, you know, keep hammering it, keep hammering it. Let's get to 500, let's get to 750. And I think that is what I think it has a lot of people worried. They don't understand the ramifications of that.

Chris Prybal: Yeah, there could and probably will be unintended consequences of this activity that maybe doesn't bite us all in the butt, but it increases fees associated with some of these contracts or it reduces the bid-ask spread in some manner that it cannot happen again, which ultimately hurts us from a commission trading point of view. We'll stay on that I mean, it could happen today. It could happen a week from now it's, they can't let this continue to occur. 

Patrick: Well, what I find fascinating is you look at your trade, you saw something that not everyone else saw, you know, across the market, and then you were able to benefit from that. But, so like once it crossed a certain line though, it became so disconnected from reality that you almost had to kind of throw your hands up and say like, okay, what's really happening here? It's such a weird mix of very astute market reading and then just completely unregulated chaos.

Chris Prybal: Trading the market can be so much fun, but it is also very humiliating even when you win. Such as this case, while I've took huge profits, I missed out on over a hundred percent stock gains that would have took this option trade to even, you know, we would have been talking about a 1500 or a 2000% gain on this trade and I'm humiliated that I didn't keep it open. But at the same time, when you're seeing distorted price movements and you have a subscriber base as large as we have at Schaeffer's, you have to take care of the client. You have to think about how am I going to get these people out at a good price because it's not just me?

Patrick: Exactly. You have to remove your own ego and vanity from it.

Chris Prybal: There's tens of thousands, 20,000 contracts just on the opening day. So you're getting a lot of people and you don't know how many people added to it after, or took the position off, but there's a lot of money chasing these trades. You want to get them out at, you're obviously getting them out at a great price in the situation, but you want them to get out in an orderly fashion and not chase the market emotionally, because they see swings. So it was very difficult exiting trades.

Patrick: I see you had you’re, for one, for the event trader, you had your final partial closed on the 15th. And then for your, I think it was options under $5 was the final partial closed a week later on the 22nd. What was going through your mind when you were closing these out? Did you have any incline that this was, that this chaos was about to happen? I mean, like you said, you had to; you have to protect your investors.

Chris Prybal: I never thought I would advance to this degree. There were drivers in place that suggested it could happen. But really, when you have this wall, this wave of liquidity out in the market and it's looking for a home and it knows certain people are short on certain stocks you can punish them. I look back to my drivers and I said would you be happy with a thousand percent return on the second half of this trade? And any person I know would be like; you know what close that out. That's, a great job and the second trade there that got to 700 and stocks you, that was actually a 1200% exit. So when it gets to that level, where you say to yourself, man, this is awesome this is really good, I'm okay taking the profit then and moving on because we know how the market works. It goes up and it goes down and that 1200% could have easily fallen to 600% the next morning or even less, you know, I could have been closing the second half out less than I took the first half out. And that's really never a good situation to be in you know, you kind of feel like, well, why didn't I take all of it off?

Patrick: Exactly. So I've been working here at Schaeffer's for going on four years in April. And I have never seen something like this happen before, you know, you're a seasoned veteran trader. It has, is there any context in history that we can look back on and possibly learn from about like where we're going next, considering what just happened? 

Chris Prybal: 99 and 2000 when I was growing up, there were dotcom stocks that they filed for an IPO. They began trading and they'd go up 100% in one day, it kind of reminds me of that. Option trading was not as prevalent then; today you have a lot more option volume, which can influence the stock price more. So you've got that dynamic of the low commissions, you've got retail traders. They inherently are usually long only to begin but they're learning how to trade options at a frequent rate and they like them because they can get out, get in and get out the same day. You can, you know, you got a lot of flexibilities, you know, that has amplified the effect. So to answer your question yes, but honestly, no I don't think you can do that.

Patrick: Yeah. I just, I struggled to find a comparison looking back through history and trying to find some connective tissue with it all. So then moving forward, what do you think are some long-term ramifications of the way this escalated out of proportion?

Chris Prybal: [Unclear 18:52] the increased retail crowd and that being young people taking to the stock market is a very beneficial thing for the whole of American society. These people are going to be shareholders for much longer than someone, my age or someone 65 or 80. You know, they've got more skin in the game because they're going to have to live through these changes and with them as shareholders with them empowered to make changes. And to force these companies to clean up on carbon capture and do these other things that just make sense from a society point of view, instead of a shareholder point of view. I think ultimately it's going to benefit us, I do think that we're going to get a, the market's going to run into turbulence at some point this year. I don't think the powers that be want to bring it down so quickly after inauguration.

They want to let it ride, they want; we're still in the COVID effects. They're still stimulating, there's still a lot of people out of work. So they really can't push on the brakes too much because there's a lot of people hurting out on the streets, not wall street, but on main street and the back streets. So they, got to be delicate and the fed. The fed is going to be interesting with what they say, because they kind of got a tap down on things as well, but they don't want to rock the boat because it's still a lot of people hurting. So I'm thinking when we get into June, July the summer months when it's historically weak anyway, I think you'll get a pronounced pool back there always caveats to, you know, there's a black Swan event such as China trying to take over Taiwan. That would screw with the supply chains of many, many tech firms.

Patrick: The semiconductors.

Chris Prybal: Yeah, and the economy overall, because there's always things that could cause that type of swing. But I don't think that they want to bring down a market until summertime, honestly, let more people get their job back, get back to normal. You know, I just don't, there's so much money, so much liquidity right now that any pullbacks going to be purchased. I know me personally, I've got cash in my trading accounts, and I’m waiting for a better price. If it is I'll step in and buy, you know? So there's, if you and I are doing that, there's a lot more, there's a lot of other people doing that same thing. So that's how I feel about that.

Patrick: Yeah, well, very well said. I think if we're looking for an analogy instead of slamming on the brakes on an exit ramp, we're kind of just tapping the brakes a little bit, just, you know, tap every couple of seconds. You don't want to skid out; you don't want to flip the car.

Chris Prybal: Yeah, Like the air brake system that [unclear 21:47].

Patrick: Bingo, bingo. Moving beyond Game Stop and everything else. What are some other sectors and industries that have kind of caught your eye to start 2021? You mentioned briefly kind of we're still digging ourselves out of the COVID hole, but you know, you have some projections saying we're reaching mass vaccination by mid to early summer. Are you watching these trends and trying to formulate your trading strategy for 2021?

Chris Prybal: One into 2021 I kind of made a thematic approach to it, kind of segregated companies into certain sectors or industries. Now I'll share with you, some of them obviously Carbon Capture with Biden and the Green Energy Push, Solar Power. Anything like that, I think it's going to do well, just because of the flood of money going into it. There's going to be technology advances, things we don't even know are possible are going to happen. And you know, a couple of years from now, we will probably going to live in a different world than we are now and it's due to these companies. You could go into 5g, there are a lot of companies in 5g that I like. You could go into 3d printing, 3d printing companies that are revolutionizing the world. 

With GameStop, you could just look at gaming companies. I know you like Draft Kings from previous episodes [unclear 23:18] background, e-sports, e-sports gambling is a huge business, marijuana legalization. That's going to happen this year across the country. Any type of reopening trade, you got Bit coin mining and then probably the biggest one of all is revolution in genomics. This COVID kind of put people under the microscope and set up like RNA sequencing and they sped up development and that's going to benefit us all, whether its cancer research or a plague we don't know about. We're going to be better prepared to handle it.

Patrick: Absolutely. 

Chris Prybal: So, I mean, it's always fun. That's why this trading game, it's very exciting. I'm glad I do this I wouldn't do anything else, but at times you can be humiliated by your own winners. I mean, it's an exhausting game, but how else to make money?

Patrick: It's crazy you know, I can't think of any other aspect of life where if you turn in a 706% return, it's construed as almost like kind of a loss, like what other, you know, situation in sports life is that like, and that's what makes investing so unique. And I think it is starting to ensnare a lot of young traders. So yeah, I really agree with all of your insights into 2021 I think it's going to be very exciting. We've, with big macro events, such as the pandemic, there's always a shift to new technology, a shift to a different way of life. You think of the remote learning or the remote working, you know, we're doing this now over zoom, you know, who would have thought that that would have been so prevalent a year from, a year ago. But it's definitely an exciting time to be in investing. Couldn't agree more.

Chris Prybal: I'm glad, I hope everyone's happy and healthy and they stay safe and we get through this, but man, the markets sure have given us a lot to talk about and we're in the right place with that. Aren't we Patrick?

Patrick: Yeah. I couldn't help, but think that in the past week of like, we are at the center of the universe right now, in terms of investing, and it’s exciting. It's a little daunting and stressful. But hey, the only cure is for that is just a trip to the golf course. Am I right?

Chris Prybal: You're right about that. I can't wait to get some new Callaway woods tested not I changed my budding stroke. I'm left tad low now, it was really good. However, I'm putting on a mat inside my house because of the cold weather. So that's kind of like, is it real or is it not real?

Patrick: Be careful with those mats man, like I did a lot of mat work one off-season and then like the first couple of months, I was just rolling everything, no feel at all. I don't know, maybe that was my own fault, but those mats scare me.

Chris Prybal: We'll have to play golf this year, Patrick.

Patrick: Yeah, absolutely. Chris Prybal, Schaeffer's investment research. Thank you so much for coming on your second time on you were my first ever guest. Hopefully, you know, we can make you a frequent contributor.

Chris Prybal: Yeah. And for those listening, go to Schaeffer's research.com. See how many big hits we've had recently. We're going to keep it up so check this out.

Patrick: Chris beat me to the promotion. Schaeffer's research.com, check us out. Instagram, Twitter, you know, our website, we were overhauling our whole front page, so you can see everything as quickly as possible. We're definitely working on some exciting things for the future and hopefully everybody can be involved.

Chris Prybal: An exciting time isn't it?

Patrick: Alrighty, Chris, be safe. I'll talk to you soon. See you in the new office.

Chris Prybal: Thanks to everyone for listening.

Patrick: Take care, cheers.

Adding commodity options to your investment portfolio may be used as a method to decrease your overall portfolio risk. Most solid trading brokerages often both equity options and commodity options to clients. Understanding which security is best for you involves an analysis of the risk associated with them. For a beginner who is trying to learn to trade options, learning about the different varieties available in the market is key.

The Myth about Commodity Options

It is a straight-up myth that commodity options are safer than equity options. It is true that the scope for profit in commodity options is unlimited if prices fortuitously skyrocket. However, a prudent trader also knows that potentially unlimited profits can be accompanied by a high level of risk as well.

In order to learn to trade options, one needs to understand which variant is appropriate for his or her investment plan and trading goals. As you learn to trade options, you can diversify your portfolio with both equity options and commodity ones. Equity options are good if you are interested in a short-term play on an equity traded on the U.S. stock market. Commodity options will give you short-term, high-profit gains on a commodity that exists outside of the standard U.S. stock market.

Minimize Risk with Precision Timing

For a commodities trader, it's typically suggested to buy commodity options when the targeted market is at a low. This is because the most predictable course that will follow is that the commodity price will increase and allow the options trader to capitalize exponentially on the increased underlying price. By correctly calling a commodity's bottom, a trader decreases his risk of a losing position. Obviously, it is not set in stone that if prices for commodities are low, they will always subsequently bounce back up. In some circumstances, the commodity's value may decrease even further. However, as there is always a degree of uncertainty in options trading (regardless of the underlying asset), the odds of the trade going against you are always going to be higher than the likelihood of the trade going In the correct direction during the specified timeframe. 

It is typically not recommended to buy commodity options when the commodity pricing is near highs. It may seem like an attractive prospect to do so because of the support of price growth, but beware of the forces working behind the commodity market. Since commodities are tangible items directly available to consumers, the market forces of demand and supply regulate the market. If the price of a commodity is extremely high, there is no logical guarantee that the next step is that the commodity price will continue to increase, because the demand and supply principles will stabilize the price. As you learn to trade options, be wary of relying too greatly on momentarily attractive market trends and be sure to have an edge before trading options.

What Level of Risk is Associated with Selling Commodity Options?

The best options trading strategy, whether it is commodity options and/or equity options, is diversification of strategies. Traders can spread out risk by having a variety of long and short options. We understand that most traders choose not to sell commodity options as it exposes the trader to significant risk if the option is assigned to them. However, it's strongly recommended that traders apply the strategy of diversification, aka application of risk management, to the usage commodity options as well.

If a trader writes an option over a relatively stable asset (i.e., the prices of which do not fluctuate), it is highly unlikely that the option will be exercised. This means that the trader keeps getting a premium and the option expires as the holder sees no benefit in exercising it. Contrastingly, it is advisable to buy commodity options when the price of a volatile asset is low. This means that the trader can exercise the option when the price fluctuates and make gains depending on whether he or she has a call or put option open.

Can Commodities be Volatile, Too?

As a general rule of thumb, commodities tend to be less volatile than equities. This is where the idea that commodity options are "safer" than equity options stems from.

However, as we have mentioned above, there are quite a few different kinds of commodities. The risk that an investor is exposed to depends solely on the type of commodity being played. As you learn to trade options, you will realize that no commodity market is completely risk-free. Two of the most commonly traded commodities are crude oil and gold. The global markets for these goods fluctuate the most out of all commodities. As a consequence, the prices at which the commodities are traded in markets also fluctuates and makes them the most volatile commodities.

On the latest episode of the Schaeffer's Market Mashup podcast, Patrick is joined by finance author, trader and avid New York sports fan, Adam Warner. They chop it up over the VIX/VXX's recent movement (9:05), the role of social media in retail investing (18:45), and whether a market correction is upon us (21:50) and, in between, plenty of Julius Randle, Lenny Dykstra, and Mets talk!

Transcript of Schaeffer's Market Mashup Podcast: February 25, 2021:

Patrick: Ladies and gentlemen, welcome back to the Schaeffer's Market Mashup. I am very excited to introduce today's guest; I have been looking forward to having him on for the longest time so let's get right to it. Please welcome Adam Warner; an investing Renaissance man, author and trader. He's the author of Options Volatility Trading Strategies for Profiting from Market Swings; a book released back in October of 2009 which, perfect timing for market swings. Adam, how are yah man?

Adam Warner: I'm doing good, thanks for having me Patrick.

Patrick: Good, good. Well I guess I want to start and congratulate you Julius Randall making his first NBA all-star team and the Knick's, first since Kristaps Porzingis in 2017, 2018.

Adam Warner: It's been great. I was looking at it. And, I don't know if he's better than like Bam or Felter who got that left off, but he's been fantastic. He's getting triple doubles and getting forty points. It's fun actually, that the Knicks are relevant for the first time in, kind of forever. 

Patrick: Yeah, I really like the pieces they have. I have a couple of friends in Dayton, huge Obi Toppin fan. I see a lot of Shawn Marion in there with him. So yeah, like you said, I never hated the Knicks, you know? Well, one, I wasn't threatened by them as a Celtics fan. Two, when they're good, it's good for basketball so I'm happy you guys are on the upswing.

Adam Warner: Yeah, I mean, I'm old enough to remember the 90's extremely well and last year with that Michael Jourdan thing was on and my son came in was watching, I'm like, you know, he has no memories of the Knicks ever being good. I'm like, you know the Knicks were actually really good in the 90's, you know? Year after year they were, you know? Find and the game was so different and they were relevant, you know? And for 20 years they've been terrible. 

Patrick: Oh yeah.

Adam Warner: (2:15 inaudible) relevant, I mean they're not gonna make it to the title but for them to make the playoffs it's progress for them and yeah they got some good, young guys here. And Quickly is very promising and yeah. Like so Toppin, I was so excited when they drafted Toppin and I thought he was (2:26 inaudible) in college last year. And no one knows, you know? Dude, it's the Knicks so what they'll end up doing is they'll trade five of them for, you know, a 32 year old superstar but decline.

Patrick: Well I looked at Toppin's minutes and it was classic Thibodaux, just like playing him 10, 11 minutes. It's like, come on, man. Get 'em out there. Well, since you're a new guest, I want to start from the beginning. Give me a quick snapshot of your background. I know you were Johns Hopkins majored in Econ, so another fellow D three-person here; big lacrosse school. Tell me how you got to where you are today, what you're doing now, just kind of, break it down.

Adam Warner: I started a business as a Market Maker on the American stock exchange. It started in late 80's and, it was a very different business back then. We had single listed options, in other words, if you wanted to trade like Caterpillar options, you had to come to the Amex. If you wanted to trade Phillip Morris options, a couple off the top of my head, you had to come to the Amex. And so there was no, you know, online trading; it didn't exist at the time. Online didn't really exist at the time. So it was a good business for a while but by the end of the 90's, a lot of things happened to make that poor business. They went to decimals and then to pennies so it's heightened on the markets. The exchanges started all listing everybody's options so you would now have competition with all the other exchanges. And then you had online exchanges popped up and before you know it the spreads, went from, you know, a quarter to 2 cents. 

Patrick: Right.

Adam Warner: And you had the match other the markets. And so, there's no edge in being on the floor. So I left in 2001 and I figured as long as I can, like, train again, I might as well. As long as I can trade online, I might as well be able to dictate my positions. So I started trading online, this about 2001 and I subscribed to some websites and one of them was Real Money. It was under the street.com umbrella and they also have a site called Street Insight. And one time they said they were looking for writers. So I sent in an email and they said sure. So, I got my first ever writing gig and started writing about options and volatility and whatnot for street insight. And then I went (5:05 inaudible), I was going to switch. I guess I started reading (5:08 inaudible) and I might be dating myself (5:11 inaudible) Paris fantasy. 

Patrick: Yeah, you lost me.

Adam Warner: It was this fabulous site at the time. And, it turned out there was a non-compete agreement between the two sites, so I had to leave. I had to take I think, I forget it was either 3 or 6 months so I started to, it was about the time blogs were getting popular. 

Adam Warner: So it was, I have a few people that read my (5:30 inaudible) so, let me just do it in blog form. So I did it and it got really popular and my most popular topic was, oddly enough, Lenny Dykstra. As a big Mets, I am a big Mets fan and he started writing up an options column for Kramer's. I forget if it was the street or real (5:56 inaudible). And he was like making these outlandish recommendations and getting these outlandish representations of how well he was doing. Then it became like a running joke, he was recommending deep calls and these stocks, and he was like. 

Patrick: Lenny Dykstra was?

 Adam Warner: Lenny Dysktra was, yeah; and Lenny Dysktra investment guru. He doesn't have any incarnations missing. Anyway, so here's this guy who was like, one of my all-time favourite players, but he was just (6:19 inaudible). I loved it as a kid, but he was just running these absurd options advice columns and he was like, misrepresenting his returns. What he do was, he would like mention only the winners that had closed out, but, let's say he had one that went against him, he would like literally never mention it again. So you're claim like he had like, you know, 99% winners, which he very well might've. But what he didn't mention was like, the losers were like, the winners were tiny and the sheet losers were just absolutely enormous. And if you actually looked at the numbers, the losers totally wiped out, any wins he had. Anyway, obviously, they did this and they once got picked up by (7:06 inaudible) cause I think they covered him once and I sent an email, like maybe, clarifying what he had done and then they linked to my site and they blew up my site up cause I got so many hits just from, kind of, the Lenny Dykstra. I was very sure that Lenny obviously did a million other things that got him into trouble beyond. 

Adam Warner: His options that (7:28 inaudible).

Patrick: Well that's the long story short is never meet your idols, really.

Adam Warner: Right, right; it did cross my mind once on Twitter once where there was like a music video, I think. And I don't think he ever, I never mentioned that I used to write about him. Anyway, so for the blog I started doing (7:45 inaudible) thing got outdated really, you know, with Twitter and whatnot. So I just started doing freelance writing after that, which led me to a Schaefer's. I wrote for, column for Schaefer's for a number of years. Plug here, I love Schaefer's, love the people.

Patrick: Yes, there we go. I was sitting there waiting like, here we go, come on. Let's get it. 

Adam Warner: No, but everyone I ever dealt with was so nice, knowledgeable and I really loved it. I just kind of ran out of, like, daily ideas on telling people. I don't know how many times I could tell people, you know, some of these esoteric option products are, you know, (8:30 inaudible) but they're really bad, long term. So right now I just, I don't write much anymore, but I do trade, I guess. I do more long-term investing now. I don't do much in my 1short term training. So, just; you know? Like.

Patrick: Well, it sounds like you've had your hand in everything and your Twitter profile, which, you know, we'll get into that later; you know? It says in VIX, we trust so that's kind of where I'd like to start. 

Adam Warner: Sure.

Patrick: What is a VIX crush? And did it play a role in the recent highs and the, you know, subsequent pullback from 2020 into 2021, you know? In the past week, you know, we had that brief, very brief, dip below 20. Unpack that a little bit, you know, to start. 

Adam Warner: Well, I think that, I mean VIX is better looked at as reflecting what's happening as opposed to predicting. So, I think, just kind of, VIX is a perpetual, 30 day at the money-ish option on (9:43 inaudible) and it measures the volatility of that. So it's extensively predicting what the volatility of the market is going to be over the next 30 days. But, when you look at the numbers, like, I used to run numbers. I believe this is from a book where if your offset VIX and say like, how to do predicting the feature versus how to do just predicting what just happened. And, I don't have the exact numbers off hand, but it currently, hit at almost nil with, going forward and it correlated an awful lot with what just happened. So, a bit of the crash might be, you know, the market was very strong and then it kind of tapered off. But, you know, it's drifting a bit now but it's not doing anything too violent and I think the crash is more just reflecting. Like, it got kind of high last year and its still, you know, 20 is still a historically high number. The, let me just look this up real quick, the all-time median is about 17 and a half. 

Adam Warner: So, you know, we're still even at 20 which seems low compared to last year is still on high side, all the time. So I think it's just, you know, sort of drifting off the high number. What's happening below the surface is the realized (11:04 inaudible) SPX that is absolutely imploded. That was in, you know, the 30's, the 40's, the 50's last year. The 20's recently it's down to about six. That's a very low number. 

Adam Warner: Like, if you use the rule of 16, where, 16 is (11:26 inaudible) is equivalent to about a 1% move in the markets. In other words, it picks the 16, is expecting a typical day to be about a 1% range. Realize what I'll tell you, which looks back to about the last 10 trading days, the number six. It means the typical range lasts 10 trading days is, you know, less than half a percent. So, you know, the actual ranges are tightening up and (11:50 inaudible) is just kind of following that. 

Patrick: It's been a lot of consolidation.

Adam Warner: Yeah, I think we're tight. I mean, I'm terrible at guessing where the market's going, but, that's what it seems like. You know the bond yields are going up. So it seems like the market's just kind of, you know, drifting a little quite right.

Patrick: Yeah.

Adam Warner: You know it's not much of a drift. 

Patrick: So

Adam Warner: At this point.

Patrick: You've mentioned on Twitter a couple of times recently, not saying that I stalk your Twitter, but I did do my research here. You mentioned VIX features, the VXX. To start, can you differentiate between the VIX and the VXX for those who aren't familiar and then give a snapshot for what you're seeing with the VXX lately?

Adam Warner: Okay, sure VIX is an index of actual options. So VIX is a hypothetical 30 day option on the SPX (12:52 inaudible) that option. There are futures on the VIX, which have fixed expiration dates and they; to simplify, it's kind of a bet on where the VIX is going to close on that date in the future. It's a little more complicated than that because; I don't even want to get started on the whole like.

Adam Warner: VXX is, essentially a perpetual 30 day future on the VIX. So it's more or less a combination of the two near month VIX features. So it's always 30 days. VIX itself is not tradable. You can't trade the actual VIX. 

Adam Warner: You can trade the VIX future. That's something very different from the VIX. The VIX itself is not tradable. VXX is tradeable; the idea is, essentially is, you can trade future volatility in the form of a, well it looks like an ETF; it's a little different, but it's like a stock. And so it looks and acts like a stock. The big issue is the VXX is not a stock. It has structural issues that are really important. It declines over time because the VIX features are in the tango almost all the time. Which, what that means is, you have to, for VXX, you have to look at the two nearer months and the further month out is almost always higher than the nearer month. So in order for VXX to maintain 30 day duration, it effectively has to sell the nearer month and buy the outer month. It doesn't necessarily do it that way. I believe they can do swaps and non-products, but it effectively has to buy time over and over and over and over again. That has the effect of causing you to lose value over time. People come into this, see VIX, and expect it to go up or down but they should not expect VIX to go up. They say "hey I cannot buy VIX but I can buy this VXX", so they buy it and in like a week later it's down and, you know, and VIX up or flat or floating down or whatever. And it's just been a disastrous product over time for a long-term investor. You shouldn't buy it for any length of time. It's fine as a tradeable way to play a very near term, moving. And VIX it correlates pretty well very, very, very near term. It does not correlate well with, like, (15:28 inaudible) length of time. I should also mention that this is VXX too. There is an original one, the original VXX was structured as if it was like a node of some sorts. So it had had a fixed expiration date from inception to the fixed expiration date, which was a decade away. I think it lost something like 99.9% of its value and then they created a new one that started a few years ago that now has about a 30 year deed. Although I did read they could cut the plug at any time, but. 

Patrick: Wow.

Adam Warner: So this is actually VXX 2, but it's the same dynamic. 

Patrick: Yeah that just doesn't roll off the tongue as nice as VXX. How would a retail trader read the VIX and adjust their trading strategy?

Adam Warner: I think VIX is a very good proxy for how good the market is for traders in general. Like, it's a bit like the pool of available profits. Like a low VIX, means like, you know, you really got to trade tightly and you technically have to play larger because if you want to get certain returns and whatnot, you'd need to trade more, you know? Maybe I could trade bigger. So with VIX higher it implies that the trading pools is just, you know, the potential profit is just bigger, you know? And you can branch it out to, you know, momentum stocks, you know? Whatever, you know; just higher VIX environment is just a better trading environment. So, you know, you could, obviously it's more uncertain if you lose, but, you know, you're going to be optimistic. It's more opportunity to make the trades. So, I think the best way to look at it is that, I don't think when VIX actually levels are not great for calling the market you know? When it gets extended, like, VIX versus it's moving average is something I like to look at just to see if a move is too extended. Like, when VIX goes too far beyond is moving averages I use a (17:47 inaudible) which I think pretty much the copy of the ones used (17:50 inaudible).

Patrick: Yeah.

Adam Warner: That's a decent market indicator, but VIX absolute levels, I think were just a good indicator of just the overall tradability of the market.

Patrick: Yeah, I'm looking up the VIX's10 day right now just to curiously see where it's at. Looks like, I think, five days above it, 1, 2, 3, 4, 5 days above it; yeah

Adam Warner: Yeah, it's like little above. You know, it got extended a couple of weeks ago.

Patrick: Yep, sure did. And then now it's kind of.

Adam Warner: Yeah.

Patrick: Levelling out.

Adam Warner: Here and now it's pretty close, it's kind of nothing much to really look at there.

Patrick: You're right though, I think that's definitely something that an investor or a retail investor, just trying to get as much information as possible can keep an eye on, you know? Just another alarm bell that they can use to say like, "oh, okay; you know, it breached here, let's keep watching it." I do want to pivot a little bit to the role in social media and in retail investing, given the, you know, I guess 2021, really is when it really blew up. Don't want to focus too much on the GameStop stuff and everything that's been played over. I'm so sick and tired of seeing that gene taker. But I do want to focus on the fallout. You are very active on Twitter. I want to try to understand how a retail investor can parse out good data from bad data. There is so much out there when you look on StockTwits, on Reddit, how does one kind of separate the, you know, real from the fake there and how has that impacted your own trading mind-set?

Adam Warner: That is a good question. I've never gone on Reddit, so I don't know. 

Patrick: Good, good.

Adam Warner: Exactly, I knew one of the original StockTwits people, like just wanted the ones they recommended was probably (19:46 inaudible) that must be like 12, 13 years ago. I don't remember exactly what, I guess it cannot be because Twitter. It must be a little more recent than that. But StockTwits is better in that they do not just recommend anybody, you know? You have to have a bit of a track record for them to plug you and plug your material; it's difficult. I think, you know, the general rule, if someone's putting their name behind it and putting actual picks or advice in real time, you know, that stuff's good. You always got, watch out for like people to put out just the winners. You know, it's trying to show you how good they've done and you know, it's hard to trust. I don't want to use this as a total blanket rule, but when someone's not putting their actual name behind I think it creates a higher bar. I understand some people just cannot for maybe regulatory reasons or for some other reason, but, um, I just think you should have a high bar if the person's not attaching their name or a tattoo, you know, real time numbers and trades and whatnot. So it's dangerous. Cause I think, you know, like you said with Game Stop, you know that was a winner, but yeah, no one talks about, you know, the countless runs or, you know, the (21:08) people. Is like bad ideas, they'll pile them at the top and pile doubt at the bottom. And I would just recommend being careful. Just look at people who have a track record.

Patrick: I think in the same way that when you're reading a news source these days, you have to look and see, okay,  who is, you know, who owns this organization, you know?

Adam Warner: Yeah.

Patrick: You have to do research, not on what the person is saying, but who exactly is saying that. And I think that gets glossed over sometimes where; someone can, you know, you can look up someone's charts that they're peddling and it can be an echo chamber of like, "yeah, yeah, yeah. I really agree with that." But then look and see where this person has come from I think it is another step that needs to be taken. With that said, what are you looking at really in the next six months to so, because we've got Johnson, Johnson's vaccine is awaiting approval from the FDA; so six months to a year what are you keeping your eye on?

Adam Warner: Well, like I'm totally optimistic, societally with the vaccines and I think if anything they're being under sold. (22:17 inaudible) you know, if you look, they are doing a great job of stopping, you know, severe cases. They just don't know the answer on like decent amount of cases. They might be good for stopping that too, but they're demonstrably doing a good job with severe cases so I'm very optimistic in the real world economy. I guess the question is more, do the market price (22:44 inaudible) already because it's been going up in anticipation of this recovery for a while now. And that's where I'm a little questioning of that. Are you going to get, like, you know, a sell the news type thing, you know, whereas the numbers demonstrably get better. And, you know, I am at all remotely an expert at bonds but are the bonds telling you that, "hey, you know, the economy really is going to recover," and, you know, are we now I'm going to start worrying about inflation and, you know, whatnot and, you know, start, you know, if I have it priced in the recovery area now that it's going to just start pricing in. You know the not great effects of too fast a recovery. But, I'm not bearish but I'd say, you know, there is a question of like how much of this is already priced in and we are mostly there at this point and the actual market.

Patrick: Yeah, you know, I remember the day after they officially declared Biden, the winner, there was also vaccine news; I can't remember which one. 

Adam Warner: It may have been Pfizer news I think. 

Patrick: Yeah, I think it was the Pfizer and there was a huge explosion and it was just one of those days where everything was just, you know, shiny, perfect and new and you wonder now with three months later or so, was that it? And I feel like that is kind of the question people need to kind of start asking themselves and saying like, "how do I get ready for a potential correction and whatnot." And I feel like keeping an eye on the VIX, keeping an eye on the VXX are ways to strategize when it's coming. Am I correct in saying that or?

Adam Warner: Yeah, I mean, I think a good way to look at VXX is it behaves very much like a market cut. Like it decays for a different reason but it is a reasonable, it depends, downside. I mean, you know, and if it loses money for you it is not necessarily the worst thing in the world. 

Patrick: Yes.

Adam Warner: Because it might imply you're doing well with everything else. 

Patrick: Exactly.

Adam Warner: So, you know, a market heads, you know, the same you would look at maybe buying some puts against a portfolio, you know? I mean, VXX, I (25:03 inaudible) recommend this, but I'm just saying, like, it has similar behaviour to if you bought an index (25:10 inaudible). So it's not terrible in that respect. The dynamics of the decay are different, but the effect is the same, you know? An option decays because time is running out. 

Patrick: Right, right.

Adam Warner: And VXX decays because of the Tango issue. 

Patrick: Yeah.

Adam Warner: Because of the rolling futures, more or less.

Patrick: One final question, who finishes with a better record this year, the Red Sox or the Mets? 

Adam Warner: Oh, that's easy, the Mets. 

Patrick: You know what, I'm afraid to say; I am agreeing with you

Adam Warner: We have Captain Money Bags now owning the team.

Patrick: Geez.

Adam Warner: And the Red Sox they are getting profits right now. 

Patrick: The Tampa Bay Red Sox over here; are you Jets or Giants?

Adam Warner: I'm a Giants fan man. My family had season tickets from when I was a kid until they switched stadiums and they made you buy these, cause at the time seat licenses were big and then it was like throwing money down for no reason. 

Patrick: Got it.

Adam Warner: I just wasn't young as much at the time anyway, but I am a Giants fan. They are periodically great.

Patrick: Yeah.

Adam Warner: But the highs are very high; I remember one of the Super Bowls versus how good they generally are, so that's fun.

Patrick: It's a Super Bowl; it is all that all that matters. 

Adam Warner: Yeah.

Patrick: Well then, I guess, in the last one will be, better record Giants or Bangles?

Adam Warner: Well I like Joe Burrow better than Daniel Jones I would have to admit so I do not know. I mean, I do not love the way the giants have. 

Patrick: Yeah, you I think.

Adam Warner: Managed the last few years.

Patrick: I think we got you. 

Adam Warner: So we got a little better this year.

Patrick: On that one. 

Adam Warner: Yeah, I think the Bangles long term, you know, they got another high pick this year I assume and I think they are headed the right direction. The Giants, I feel like they do business terrible and the Bangles (27:06 inaudible).

Adam Warner: So that is one fact in the Giants favour but, the actual team, I do not think the Bangles (27:10 inaudible) going forward the next couple of years.

Patrick: Well, we will see; hopefully, you know, there will be actual people in the stands this fall. 

Adam Warner: Yeah, hopefully.

Patrick: So, but that's about it for me. Adam Warner thanks again for coming on. Do you have any thing you'd like to plug or last minute things you want to, you know, sign off with?

Adam Warner: Yeah, I'd just like to tell them to get your vaccine, that's going to help everyone. 

Adam Warner: As soon as it's your times on the line, go get it. It's going to.

Patrick: My parents are getting theirs tomorrow or no, today and tomorrow. So, 

Patrick: You know a lot of good feelings in the Martin family right now. So, yeah, go get that jab. 

Adam Warner: Exactly.

Patrick: Well, other than that, thanks again for coming on. Maybe we can do a summer episode and check-in on all our teams and, you know, kind of recap what's been going on.

Adam Warner: I anxiously await my Mets victory lap, so thank you and thanks for having me.

Patrick: There you go; yeah all right. We will sign off right there. Thanks again, everybody. Cheers.

On the latest episode of the Schaeffer's Market Mashup podcast, Cboe Global Markets’ Head of Product Intelligence Henry Schwartz returns for the third time to discuss post-election volatility (4:58), how options traders are reacting (10:28), and advice for the retail crowd just getting into options (18:15).

Transcript of Schaeffer's Market Mashup Podcast: February 9, 2021

Patrick: Welcome back to the Schaeffer's market mash up, please welcome back. Five 10 Henry Schwartz, CBOE global markets is head of product intelligence, Henry, you hanging in there, buddy?

Henry Schwartz: Oh, I am Patrick, thank you. It's been a heck of a year and it's only February. Yeah

Patrick: Yeah, it's, did you ever think when we did a pre-election volatility episode that we'd be talking about GameStop two months later?

Henry Schwartz: No, I thought whatever happened, you know, that, we'd get over the hump of the election and things would just settle down, but nothing settled down. I think Maura has gotten kind of stirred up in the, you know, the first month of the year and it's great, but I don't, I'm exhausted.

Patrick: You're telling me, well, in general stocks tend to post gains during periods of transition to a new us administration within these transition periods between incoming and outgoing US presidents, stock market performance tends to become more dependent on the economic cycle rather than the actual election results. I want to at least start with some context first. How have markets fared following previous presidential elections and historically, how have stocks performed in a new president's first few months on the job?

Henry Schwartz: Sure. So I dug up some data because it's really interesting, you know, a lot of us kind of coming from the pure option side are, you know, it's ingrained in your training that there's a normal distribution and there's a random walk. Which means that, you know, there shouldn't really be these timing effects around elections or around months or even around days of the week. But there are right? And so you know, I pulled up the STX and actually SPF and Vicks over the last three or four election cycles to see kind of how things played out and you know, November, December they tend to be good, good months for the market in general, right. so, you know, elections kind of bring a lot more into that mix, but over the last, I think the last eight election cycles I was able to look at you see generally good performance, I think, except for following 2000 and you know, and that was the dotcom bubble bursting there. but over the last three elections, you know, I think every year has went up more than 20% on the S and P and then I drill down into, you know, specifically what we, you know, what we were talking about, you know, November, December, January, like, you know, right in the midst of where we are right now. And in general you know, what I saw is November tends to be a little bit of kind of a waffley month, historically, you know, especially, I think in 2012 we were down in 2016, we were down in November, but then December and January things kind of popped back into positive. And that was true for, I think the last three election cycles. So, you know, and then with that, you know, as you kind of expect, if you get a couple months of two or 3% returns, you know, volatility tends to come out. And so you know, after 2016, even though that, you know, that was a surprising election for a lot of people. You know, we had, if you remember, like watching election night you know, when Trump won the future sold off, you know, huge, like, you know, three and a half, 4%, and then it all flipped around and we were up by the morning. You know, looking at December and January tends to be pretty strong. And that's kind of what we're seeing now so, and then there are factors of, you know, whether or not you have one party in control of presidency and Congress and all that that tends to help. So kind of where we are right now with a you know, one party in control is, actually kind of the best scenario for the market. And, you know, we're seeing, you know, we're seeing it kind of play out in front of us.

Patrick: Yeah. And I think after the November election, we, a new scheduled event was seemingly created the January 6th, Georgia runoff election. So it's like, it's almost an unscheduled scheduled event. And I feel like that plus the insurrection at the Capitol that happened [unclear 04:54] in the ensuing weeks, threw everything into disarray. But can you explain to listeners the type of month that Wall Street just endured? And it's funny, I looked back at our older episodes and you made a couple comments that proved prophetic about volatility saying like, you know, it, I really hope it just chills out after the election. One of the times you're like, hopefully in the rear view mirror.

Henry Schwartz: Yeah. Well, the chill out definitely has not happened yet. You know, people have been looking for it, you know, we saw, I think one of the reasons I've mentioned that is because, you know, right into you know, late October. Basically we saw some big directional trades in Vicks and fixed options where they were buying these put spreads or ratio put spreads that basically would make you know, I think it was 20 to 40 million bucks if volatility finally cracked below 20, you know, really headed back down to, you know, that kind of long-term average that's in the 15 to 18 range. And so that was a very kind of, bullish or optimistic view on things coming back to normal. You know, we also saw some, we also saw volatility kind of holding, you know, especially right into the election you know, and we can play ball. I spent all of last year, you know, after topping out at the 80 to 82% range, which was a new record. It's taken months and months, and it's barely even approach 20. And now we're, you know, we went into the election around 30 and even though, you know, that actually turned out to be more of stable outcome than some people were worried about. There has been plenty of these catalysts to keep people, you know, I guess a little bit on edge as far as, you know, we're not quite out of the woods yet. Obviously, COVID is still a big issue, it's kind of seems like things are on track to have that be completed someday. But we still see a lot of things to be concerned about. And then, you know, events in Washington on January 6th were a big deal. And it was really interesting to see, you know, I mean, I was watching the market super closely that day and watching, you know, the coverage of it. And I remember seeing, the market weirdly did not react like you kind of, you know, sometimes you see a disaster taking place and you know, you'll see a really sharp selloff. Everybody gets scared, which is pretty normal. You know, we were up 2% over 2% that day. And then, you know, things started to unfold and the markets sold off a little, but you know, basically I think we slipped back about a percent, you know, you didn't see an explosion in volatility. Which, you know, was really interesting, because a lot of people were like, well, that's, you know, how can that be? And, you know, I mean, I think that as major as that event was, you know, the market is focused on, you know, kind of the current situation, which, you know, we're in a severely kind of hampered economy because of COVID. But then you have all this stimulus and you have, you know, the fed, you know, basically saying we're going to make money easy for a long, long time. So those bigger currents, I think, are kind of, what's driving, you know, traders and investors, and there's a lot of capital in it and it's, it's flowing, it needs a place to need a place to land. And, you know, in general, that's why you're seeing pretty solid performance on almost all assets.

Patrick: Do you think if you remove the context of the pandemic and a new administration, if something like the Capitol insurrection occurred as a more isolated incident, it was of course, connected in the fabric of a lot of other components of life. Do you think that then would have created so much net have resulted in a spike of volatility or are we and basically are we just so numb to these events that continue to transpire that they're really just not registering?

Henry Schwartz: I mean, I don't know if we're, if the market doesn't care, but the market, you know, my market adapts to incoming information and, you know, in slow times, you know, something out of the blue can scare everybody. But, you know, the way things have gone for the last year when you've had, you know, basically crisis after crisis, I think that we're not, we're not numb to it, but the market's not that concerned about some of these individual events which, you know, for whatever reason. You know we're, the market was pretty quick to kind of identify that as a one-off, which, you know, are in the market definitely can shrug off a one-off event because it's, you know, it could be a horrible situation, but the market is basically saying, well, that happened. And what will things look like two years down the road? And that's, you know, I think that's the dynamic going in.

Patrick: Yeah, that's a good point. So when we look at these huge events that we continue to live through, have you, how have you observed ways in which market participants are managing their risk or generating alpha? I know unscheduled events were a big component of our previous episodes.

Henry Schwartz: Right. I mean, you know, it's the way that last year played out and it's, everything is continuing is, you know, we've seen a big shuffle in the, kind of the health of different stocks. And, you know, you, at the beginning, you have this rushing into the new online economy type of stocks, right Peloton and Amazon and everything else. And all the, you know and obviously these companies that we're going to have a really rough theory at airlines and cruise lines and everything else, you know, to, you know, go and take a beating. And that, you know, that kind of cycle of like, okay, we need, you know, you need to look at companies through a different lens basically it's like is this a healthy company in general? Is this a healthy company given the current situation, is this a healthy company? What's it look like, you know, if you know, as COVID goes away and people start, you know, traveling more or whatever? So, it's been an incredible time for stock pickers and, people that can kind of anticipate where the focus is going to be. And where you're going to, you know, solid earnings, solid performance. And it's been a wild, wild ride. I mean, that takes a lot of work and thought a lot more than, you know, usual, right. You could usually look at company and talk, look at their earnings growth and prospects for their business and try to make a judgment. You know, a lot of that's gotten completely shuffled up even into the, you know, some of the recent crazy short squeeze type of things, you know, that we're seeing. You know, that's its own funky dynamic and, you know, there's, people need to be able to make sense of it. And I guess, on the options side, you know, there's trades to take advantage of it, or there's just traits to protect yourself. You know, and that's what I've found really interesting is, you know, when you see big moves, you know some stock makes the 20% run or volatility moves 15 or 20%, or a hundred percent. as an options trader you want to look at that and say, okay, okay, now what are we looking at here? We're looking at a high vol scenario, maybe the put cost skewness has, you know, flipped. Like what kind of traits make sense, what kind of trades illustrate your view of how things are going to play out? And, you know, and then you have to kind of construct everything within your framework of risk and reward. And that's what I, you know, people talk to me about is there's just a lot of interest is sector rotation, there's stock picking, and then there's still, you know, there's still people that are kind of trying to do things that from a, you know, a higher level, right. And the index trading, premium harvesters or, you know people that express their view on that side of things. You know, so it's funny, it's like there's things that still work that people are still doing and they basically have to make sure they don't get kind of knocked off track when you get, you know, some of these funky situations or, you know, two or 3% swings. And so it's, I mean, it's kind of never been a more interesting time and, you know, I've done this forever and volume is off the charts. So there's a ton of activity to look at, and there's a lot of motion, you know, there's a lot of things that are changing, right? Volatilities are moving around, you know, more than they have been in a long time. And you know, you're just, it's in a way, you know, the, in the last kind of the last few years, the market kind of, you know, as much as it was a surprise to some people, the way that politics played out, the market's still kind of developed a level of comfort with it. And then you got into COVID and then that shook everything up. And now we're, you know, hopefully, you know, towards the end of that, and you're into a whole new political realm. So it's just, there's just a lot to process.

Patrick: Yeah. One thing that will remain a constant, I believe is the volume. I think the volume is here to stay. Like, what's your estimate as far as for 2021?

Henry Schwartz: You know, we when we looked at the data in early 2020 right, you know, kind of into March, right. When things were crazy and volume had exploded you know, we looked at it and said, this could be a 7 billion contract year. And you know, remember the prior record was five and 5.2 billion set in 2018. And we finished up at 7.47 billion, okay. Brand new record, like, you know, the kind of activity that really nobody's seen. And what's interesting is that it persisted through the year, right. It was not just, we got really busy for the first quarter and then the rest of the year was normal. It stayed busy and in fact, December was the busiest month of the year with average daily volume, you know, around 30, over 30 million contracts. And then January was even busier than that. January was 40 million contracts a day, which puts us on track now for a 10 billion contract year, which I think would be a stretch. I think if we, if we're going to stay that busy for the entire year, then this will be my last year in the business because I can barely keep up with it. But retail access to the market, which really picked up last year. And we analyze it a whole bunch of different ways and one of the simplest ways that we like to look at it is like, let's just look at tiny trades and figure out how many of those there are, because those tend to be your small accounts. And in the, in a framework of just looking at one lot trades the smallest possible contract, we saw that activity triple last year, you know, from like under a million contracts, a day of one lots to almost 3 million contracts a day of one lots. And that's, an enormous amount of new activity, you know, and that's not capturing all the retail. That's just kept the kind of the tiniest piece of it and we continue to see that. And, you know, that's one of the wildest things is seeing new participants coming into this market. You know, if they're coming in because they had a year working from home and because, you know, the, you know, zero cost brokerage accounts, make it a little easier to, you know, to break even on a trade, that's great. But, you know, it's, they're obviously doing pretty well because that volume just keeps on coming. And, you know, I don't see that changing. I mean, it may, morph a little bit if you know, this bull market gets tired because in general, you know, a lot of this retail small trade flow is in the form of call buyers. And they've done well because we're up 50% from the bottom in March, as, you know, if the market really stalls out and we run into more headwinds, so those trades are going to make money, right. So the question will be like, okay, how does retail, how does that segment adapt to a different market condition, right? You guys know there's different trades you want to do on a sideways market. There's different trades you want to do on a down market. And, you know, have, has retail, you know, has this segment figured out how to make money in a sideways market. Some of them have, I'm sure of that, but some of them haven't and some of them...

Patrick: But on that note, what are some specific, you know, pretend like you are talking to these people who are coming to you upset like, well, I, you know, I thought stocks only go up, like, what's going on here? You know, what would you tell them?

Henry Schwartz: I mean, I think it's funny. I, this year, like knowing, I can tell you that the retail segment has grown because I've personally gotten emails and texts from friends and friends that like the grown children of friends saying, Hey, I just started option trading. And what do you think about calls in XYZ? And I get those texts and I'm like, oh man, oh man, like, this is somebody who's never even traded stock before. And they're just going to jump right into the options. And I that my one message is there's no secret formula to making crazy returns and people have to be realistic. And in fact, I was talking to a professor and I was giving him some data. And I said, you know, how, how is it? And he said, well, you know, it's a challenge to be teaching investments, theory and diversification, and how, you know, the, you know, index, you know, SMP returns on average are, you know, eight or 9% a year on the long-term. So you know, if you use that as kind of like your lens, like, okay, you know what, if you could make 10% a year on an investment, you know, that's pretty good. There's a little risk there, he's like the problem is, is, you know, somewhat, some student will put up their hand and say, Hey, my cousin just made 300% on, you know, on this SPAC. How, what about those? And so my message for people that are new or learning the business is be realistic, put your money in the bank that you will get, you know, 0.1% interest. So that's, you know, that's one extreme and, you know, realize how good it is to make 10 or 15% in a trading strategy compared to what you would be getting on a you know, on a risk-free, you know bank account.

Patrick: Right and what I find fascinating is I found some old magazines from think money. Now, I don't subscribe to think money, but I guess we, as Schaeffer’s did from fall of 2008, and I'm just flipping through and I came across a quote that said, rookies, look for some magic bullet that will, turn any loser into a winner, sorry, folks, it doesn't exist. And that was fall of 2008.

Henry Schwartz: I mean, it's crucial, like, you know, training is, is fun. But you, it needs to be approached. You know, people need to be very smart about how they manage their money and every trade has a risk and a reward. And if you think about it that way, and you got to, you have to have a plan and there's, you know, you have to size your bets accordingly and intelligently. And like, it's, tough I mean, I don't know what to say. It's, you know, the emotional part, the psychological part is it's a tough business and that's why most people struggle. And, you know, if a bunch of option traders you buy a bunch, I mean, hundreds of thousands of new accounts over the last year have gotten into options and had some success and figured out how to make some money hat's awesome. But you better, you have to be able to tell the lock from some intelligent, you know, strategy and not, you know, not fall into so many of the traps that people fall into in terms of making trades.. learn to use the tools I guess, is you know the most important thing. You know, they're incredibly flexible options, let you position yourself and limit risk and specify a time horizon and trade volatility and direction and time decay and everything else. But you got to figure out how to handle all those little pieces of that puzzle and, some of the recent, the game stop type of activity we've seen, you know, in the last few weeks, like that's an incredible learning experience for like how things can go and what bizarro outliers, you know, can volatility to go to 600, 700, 800. Well, it sure can, it doesn't happen very often, but just never say never. So, you know, I think that's, what's been really kind of amazing and, you know, for the self-directed retail trading community out there, you know, I think options are, you know, derivatives are kind of like a chainsaw, like credible tool. It could do a lot, you know, you just don't want to drop it on your leg. 

Patrick: Like that. Yeah, you hear that everybody don't drop the chainsaw on your leg. That's why you come to the market mash up for solid parables like that. Let's close with do you have anything you'd, like products you'd like to plug that's, that are going on at CBO right now, I'm going to give you the floor.

Henry Schwartz: I mean, we have, and we’ve been so busy you know, on, you know, the information solutions group, which is my area, right? That's trade alert, that's live vol, that's Ft options, hand wick, you know, we're putting together. We have amazing technology where we're actually weaving the technologies together to even make it better. A couple of things like I would point out, like we now are doing much more with Hammond flex options, which are these options where the user gets to specify the strike and the expiration. And it could be anything that you want, I think out to the eight or nine years. They’re typically an institutional tool, but because we're, we're really focusing on that data. You'd be surprised how many small trades are actually taking place in these, in these flex options. And then I mean this last year was the year of single stocks, for sure. You know, that was the shift we saw in single stocks and retail trading and small retail trading that was the story. But, you know, the index and the ETF world is still healthy. Like there was growth there just wasn't, didn't match what the single stocks did, but, you know, CBO has SPX, which is the S and P 500, the benchmark, you know, a trillion dollars a day and premium can trade in SPX. But then there's also this XSP, which is that same cash settled European style index divided by 10. And so it's very similar to spy except its cash settled. You don't have to worry about dividend exercises. It's got some other advantages. And it's, something that, you know, like I said, the, you know, single stock, alpha, there's all sorts of activity there. A lot of focus on that, but, you know, at the same time, you know, some of these kind of higher level trades, you know skew trades, you know, put spreads, call spreads, just you know, coloring are doable and they're doable, you know, on a smaller scale using XSP. CBO also launched mini VIX futures so it's a pretty sophisticated tool, but the notional size of the smaller contracts makes it a little bit of a better fit for something like, you know, typical portfolio. And something for people to look at because, you know, volatility has been you know, last year, it was, it showed some real extreme moves. And, you know, you can look at it now and say, okay, well, you know, Vic's hanging around, you know, 23, 24, is that you know, how do you feel about that over the next, three months, six months or a year. And, you know, VIX futures let you make a direct position on, you know, on volatility which fits some people. 

Patrick: I think, I think that's a great way to account for these unscheduled events. Yeah. I mean, it's, you guys got a lot of exciting stuff. I couldn't thank you enough for coming back on for the third time. You now are, you lead the league in guest appearances?

Henry Schwartz: Really? 

Patrick: Yeah. 

Henry Swartz: That's cool. That's awesome, someday. I'll come to Ohio and visit.

Patrick: There you go. Yeah, a round of golf's on me or some skyline chili, I guess. I mean, that's really all Cincinnati has to offer

Henry Schwartz: There's that the chili on the spaghetti or something.

Patrick: Yeah, okay. So I don't subscribe to that and first of all, I grew up on Chile was supposed to be thick. I I've transitioned to enjoying the soup Chile, but I cannot do the spaghetti, but a Coney, Coney is pretty strong, I will admit.

Henry Schwartz: Okay, well, I'll check it out.

Patrick: Sounds good, sounds good. Henry Swartz CBOs global markets head of product intelligence thanks again for coming on. Six months, every six months you can just pop on and we can talk about on earth just happened.

Henry Swartz: I'll see you in the fall.

Patrick: Alright, sounds good cheers.

Stocks continued to march higher into July expiration, as the Nasdaq 100 Index (NDX – 14,826.09) closed higher for the eighth-straight week, making it the seventh time this has happened since 2000. A consolidation phase or pullback immediately followed 71.4% of the time, but even when it remained positive, stocks typically stumbled within the next two months.

This is just one of the many things telling me this rally is getting near the later innings in terms of short- to intermediate-term trends. And while any good trader knows you can’t fight price action, it is only prudent to highlight these concerns, so that we are ready to make moves if price action deteriorates before market internals and sentiment readings turn around in the bull’s favor.

Earlier this week, I highlighted on Twitter that the Invesco QQQ Trust Series (QQQ – 361.01) broke above the 261.8% Fibonacci extension level from the pre-pandemic highs to the pandemic selloff lows. At both the 100% retracement and the 161.8% extension levels, we saw prices exceed the level only to stumble for a few months shortly afterwards. I expect the 261.8% level will act similarly and be an important pivot point.

While both the S&P 500 Index (SPX – 4,369.55) and Nasdaq Composite (IXIC – 14,701.92) closed at new weekly highs, these market indices are being pushed upwards from an increasingly narrow breadth. Only a few things can happen in these situations: Either prices fall, consolidate, or breadth catches up. Divergences can last quite a while, but they cannot go on forever, and markets eventually revert to the mean one way or another. Our job as traders is to know what to look for, and how to react accordingly.

The first breadth concern that I see is that the  percentage of S&P 500 stocks that are above the 50-day moving average remains low, with only 56.11% of stocks in the index trading above it. In fact, it has remained low since rolling over from the most recent high in April. This is eerily similar to the type of price action we saw in 2015, before the market entered a two-year consolidation phase.

What has me most concerned, though, is that neither the New York Stock Exchange (NYSE) nor the Nasdaq’s Advance-Decline Lines (ADL) have broken out. While the Nasdaq ADL was able to break out of a downtrend that helped propel the index to test resistance, it did not follow through and break out like the index. This is also similar to what we saw in 2015, before equity markets went sideways and frustrated bulls for the next two years.

Additional evidence that we are experiencing breadth issues that could trip up equities is the S&P 500 Equal-Weight/S&P 500 relative ratio chart. It has now rolled over from the June peak, where it found resistance around the 2013 and 2019 lows. And while many will point out that we had a prolonged period from 2016 to pre-pandemic 2020 where mega-caps and large-caps (predominantly tech stocks) led the markets higher, that is not typical. Throughout history, you need participation from the majority of stocks for rallies to persist.   

On a positive note, though, we’ve seen multiple sectors and industry breakouts. As I’ve been highlighting on Twitter lately, we want to watch these breakouts closely. Sectors or industries that hold these levels, if we simply enter a consolidation phase, will very likely be the market leaders going forward. However, failures at these levels can lead to fast moves to the downside.

"…With the Cboe Volatility Index (VIX -- 15.62) coming into a new week and quarter around 15 – which was its reading ahead of the early 2020 Covid-19 sharp selloff, and a level from which it has bounced in recent months – a hedge of long positions to protect against mid-summer and/or late-summer surprises could be appropriate."

- Monday Morning Outlook, June 28, 2021

As we mentioned a few weeks ago, the Cboe Volatility Index (VIX – 16.80) had the potential to bounce around 15, which was the reading ahead of the 2020 pandemic selloff. The VIX spot surged on Thursday to a high of 21.29, as stocks sold off only to find resistance near the 2020 and early 2021 low levels, as it did throughout the second quarter this year. I suspect a sustained move above those levels will also come with a change in market behavior as we head into a more volatile part of the summer.

"In a week’s time, the SPX was teetering on a deteriorating technical backdrop, then rallied to take out various potential resistance levels, most notably its early May, all-time closing high. As I said a few weeks ago, if the SPX spends most of its time within the upward channel that began to take shape at the same time positive Covid-19 headlines were emerging, it would be considered a win for bulls, since support and resistance levels that make up this channel move higher with each passing day."

- Monday Morning Outlook, June 28, 2021

As we move into expiration week, it would be irresponsible not to look at open interest configurations. When looking at the SPDR S&P 500 ETF Trust (SPY – 435.52) we have peak call at the 440-strike, and peak put at the 420-strike to start the week. I reckon the market will likely be stuck in this range throughout the week, as this configuration also aligns well with the price channel it has been trading in throughout 2021, which we’ve highlighted numerous times before. If for some odd reason we were to break the 420-strike, it could see a swift move lower to the 405-strike or even 400-strike, but the probability of that happening is low. And while the QQQ doesn’t have a significant peak call level to act as resistance, it does have a massive peak put level at the 340-strike level that should act as support.

As for why I think we will stay range bound, over the past 10 years the S&P 500 has been positive in July 90% of the time, with mid-July being one of the best performing two-week periods for the index. Furthermore, over the past 20 years July has been positive 70% of the time, and the two mid-July, two-week periods on average have traded sideways.

Much like breadth, sentiment readings tell us that market participants are overly optimistic. The NDX buy-to-open put/call volume ratio just put in a seven-year low last week at 0.354, which was the lowest reading since July 8, 2014. What this is telling us is that we are in a higher-risk environment, as we are prone to a pullback. What people often fail to understand when looking at put/call levels is that we usually want to see a confluence of changes before making bearish bets outright. Two things we are looking for in particular is a rotation upwards from an absolute low, and a subsequent technical level breakdown in broad indices.  

As I have outlined, many factors are telling us we are possibly near the end of the current rally in stocks on a short- to intermediate-term basis. Market participants should take this opportunity to sell any overweight positions into OPEX and pair back their market exposure as risk levels continue to rise. Alternatively, you can hedge or choose to replace long stock positions with call positions to reduce your overall dollar exposure to the market.

Continue reading:

• The Week Ahead: Bank Stocks Kick Off Another Earnings Season
• Indicator of the Week: Is the S&P 500 Pacing for Bigger Gains in the 2nd Half of 2021?

Plenty of red-hot economic activity are due out this week and another earnings season slowly begins to roll out, with bank stocks some of the first to release quarterly reports. Earnings from bank names JPMorgan Chase (JPM), Bank of America (BAC), PNC (PNC), Morgan Stanley (MS), and Wells Fargo (WFC) are all due out this week, while Wall Street can also expect reports from PepsiCo (PEP), Delta Air Lines (DAL), and United Health (UNH). While the week starts slow today, by Thursday there will be plenty of economic data to digest, including a monthly report from the Organization of Petroleum Exporting Countries (OPEC), manufacturing data, and weekly jobless claims. This week will be rounded out with data on retail sales and business inventories. 

The economic calendar is bare today.

No companies are slated to release quarterly earnings today, July 12.

Looking ahead to tomorrow, activity will pick up on Tuesday with the core consumer price index (CPI), and the Federal budget balance set for release. 

All economic dates listed here are tentative and subject to change.

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It was a week of high highs and low lows on Wall Street. Investors returned from a long holiday weekend on Tuesday to a worse-than-expected purchasing managers' index (PMI) reading for June, which led the S&P 500 index (SPX) to snap its seven-day win streak and the Dow Jones Industrial Average (DJI) to shed over 200 points. The Nasdaq Composite (IXIC) just barely eked out another record close, as the 10-year Treasury yield inexplicably slid lower. While it was a mystery as to why bond yields were tumbling this week -- hitting their lowest level since late-February by Thursday -- the drop sent the Nasdaq to yet another record high by Wednesday's close, joined by the S&P 500. The Dow also reversed course after the Federal Reserve's June meeting minutes were released, with the central bank admitting that the recent rise in inflation was something of a surprise this year. 

By Thursday, markets were spiraling out of control, with anxieties over the global economic recovery surfacing yet again. The worldwide spread of the Covid-19 delta variant, which drove Japan to declare a state of emergency in Tokyo ahead of the Olympic Games, poured cold water on several key sectors, including those closely tied to  the economic reopening and semiconductor stocks. The Cboe Volatility Index (VIX) skyrocketed on Thursday, however, overtaking the psychologically significant 20 level mid-session before settling slightly beneath. Today, the Dow is looking to erase the near 500-point drop it suffered yesterday, and all three indexes are eyeing weekly wins. 

Biggest Analyst Calls of the Week

The brokerage bunch had plenty to say this week. Most recently, Levi Strauss & Co (LEVI) attracted a slew of post-earnings bull notes, while United Airlines (UAL) managed two separate price-target hikes, even as the sector came under fire on Thursday. Meanwhile, Raymond James recommended scooping up Sunnova Energy (NOVA) on the dip, and J.P. Morgan Securities called Whirlpool (WHR) a "top pick"  ahead of its earnings report. 

Government Crackdowns Put Pressure on the Tech Sector

It was a whirlwind week for the tech sector. Talks of antitrust regulations in Washington D.C. are weighing on Big Tech today, as the U.S. government attempts to crack down on anticompetitive tactics. Alphabet (GOOGL), specifically, came under pressure for some of these practices in Google's Android app store, which wound up knocking the stock off from Thursday's record peak. 

Amazon.com (AMZN) also touched a record high earlier this week, following news that the U.S. Defense Department cancelled its 10-year JEDI cloud-computing with Microsoft (MSFT), which was worth $10 billion and awarded to the company in 2019. 

New government regulations over in China sunk U.S.-listed shares of several major Chinese tech stocks, including JD.com (JD), which stumbled on news that freshly public ride sharing name DiDi Global's (DIDI) app was blocked from being downloaded as regulators conducted cybersecurity reviews.  

Earnings Season Starts With Banks on Deck

Earnings are back n focus next week, with bank names JPMorgan Chase (JPM), Bank of America (BAC), PNC (PNC), Morgan Stanley (MS), and Wells Fargo (WFC) all set to kick off the latest season. PepsiCo (PEP), Delta Air Lines (DAL), and United Health (UNH) will also release their corporate reports. Investors can also look forward to a monthly report from the Organization of Petroleum Exporting Countries (OPEC), especially after the organization has struggled to reach terms of a production increase. 

In the meantime, check out Senior Vice President of Research Todd Salamone's thoughts on a potential sector corrections in the second half of the year. Plus, Senior Quantitate Analyst Rocky White shares looks back at the healthy gains from the first half of the year, and what it might mean going forward.