CPI Vol Gets a Lift

Andrew Giovinazzi

Yo Pit Crazies,

A big part of Option Pit is the fact that all traders here used to be Pro Traders on a floor or at a desk at a Bulge Bracket firm. Nothing like being in the trenches for 15 or 20 years to learn a thing or two.

All of short term option trading is finding repeatable patterns. So in the Trading Desk we discussed how traders were pricing options on the SPDR S&P 500 Trust ETF (Ticker: SPY) in the CPI number.

I came up with this strangle in the session. It’s just a call and a put, you say. Well, I needed to mark how the options were going to decay overnight. I told my students the easiest way is to “mark” – as in write down the price, and see how the options perform the next day.

I had some ideas.

So You Can Do That …?

My idea was that the liquidity provider would keep the option prices roughly the same because they did not want the value of the ATM straddle to drop below 1% of the SPY value.

The SPY Jul14 435/444 strangle was $1.67 and by the end of day on Tuesday it was $2.07. That’s a quick 20% gain, give or take.

Now the funny thing was the strangle was supposed to decay .60 from Monday to Tuesday if I read my Black-Scholes correctly.

But it didn’t. As a matter of fact, the “decay” went the other way. Traders lifted the implied volatility and made it more expensive to the tune of 4 points per strike, negating the decay.

This surprised a student and he said, “they can just do that?”

Yes, they can, and I did it thousands of times in my career! I made the options do what I want but was still there for both sides of the market.

The obligation of a market maker is to provide a fair and orderly market and be on it for either side of liquidity. I knew there was no way those options would decay because no market maker would sell them that cheap. Heck, I wouldn’t.

So in the Trading Desk we bought a strangle midday, and by end of day it was up 25%. I bought 5, sold 4, and had the last strangle for a free ride on the week. I even could sell the Proshares Ultra Short Term VIX futures ETF (Ticker: UVXY) puts I bought for a profit.

More on that tomorrow to see how the implied vol shakes out. I have ideas about that too.

The Rundown

Bill had a twofer with the Invesco QQQ Trust (Ticker: QQQ) Jul21 365/364 put vertical spread closed for a 67% gain for Win the Week and Apple Inc (Ticker: AAPL) Jul14 190/182.5/175 put butterfly closed for a 109% gain for Power Income Trader