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Options Market Outlook

Options Market Outlook

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Published by AHGrimes
Waverly Advisors' research product written for options traders and volatility specialists. Includes actionable opportunistic trade ideas, market analysis, volatility analysis, and specific opportunistic trade ideas.
Waverly Advisors' research product written for options traders and volatility specialists. Includes actionable opportunistic trade ideas, market analysis, volatility analysis, and specific opportunistic trade ideas.

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Published by: AHGrimes on Oct 15, 2013
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12/08/2013

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Copyright © Waverly Advisors, LLC 2013.Please review Disclosures on the final page of this report.
Options Market Outlook 
October 14, 2013
 Action Points:
 
 Volatility in Equities saw some significant intraday spikes this week.
o
 
 This still comes within a very healthy overall environment.
o
 
Strength is concentrated in small and mid-caps.
o
 
Large caps considerably weaker and maybe more vulnerable, despite higher vol in small-caps.
o
 
Europe and Asia are strong.
o
 
 Tactical risk is only slightly elevated in Equities. Stay the course.
 
 We see three clear tactical themes on intermediate timeframes:
o
 
In Equities, the bulls are in control.
o
 
 Treasuries in the process of trend change, but think quarters to years. No short term inflection.
o
 
Precious Metals are set up for further weakness.
 
Elevated tactical risk in Equities can be effectively managed
o
 
In practical terms, this means the risk of a decline is still small, but the magnitude of that decline could be very large and volatile.
o
 
Proper hedges can help mitigate these risks.
o
 
Ideal hedges would be insensitive to vol (low Vega) and protect against a moderate decline, perhaps in the 5% - 10% range.
 
Elevated implieds and directional uncertainty complicate long vol strategies and bring risks to premium writers.
o
 
Long vol positions would likely require a selloff to be profitable, and selloff isstatistically less likely than a rally.
o
 
Long vol/directionally short-biased trades could make sense if attractive pricing can befound, or as hedges to existing long exposure
o
 
 We have been advocating fading downward spikes, which would have been quiteprofitable this past week. Be careful of going back to the well too many times;subsequent declines are more dangerous.
 
Be careful of covered calls if you do not want to be called away. There is a good possibility of astrong recovery and rally. Premium writers who are indifferent to being called away may findthis to be a very favorable environment.
 Waverly Advisors, LLC
228 Cedar StreetCorning, NY 14830(607) 684-5300
 Adam Grimes
Chief Investment Officer Tactical Investments & Research 
grimes@waverlyadvisors.com
 Andrew Barber
Chief Executive Officer  Macroeconomic Research 
barber@waverlyadvisors.com
Contact Sales:
sales@waverlyadvisors.com(607) 684-5300 www.waverlyadvisors.com
 
 Options Market Outlook 
 – 
October 14, 2013 2Copyright © Waverly Advisors, LLC 2013.Please review Disclosures on the final page of this report.
 
 Tactical Perspective:
Developing Themes
 We continue to see a number of tactical themes play out in major markets. After some weakness, Equities staged a sharp recovery and we once again seetactical risks as moderating. Treasuries deserve attention this week. When anactive market goes into a series of small range days in tight consolidation, this
 volatility contraction often sets the stage for a sharp move. In trader’s parlance,
 w 
e say that the market is in “breakout mode” meaning that any move is likely 
to see continuation. A sharp move on the daily could lead to a larger move onhigher timeframes, perhaps defining a major inflection for Treasuries and rates. Watch for followthrough following a large range day in Treasuries this week.
Russell 2000, Cash, Daily Gold Futures (COMEX front month, continuous), Weekly 30Y Treasury Futures(CBOT front month, continuous), Daily 
 
 Options Market Outlook 
 – 
October 14, 2013 3Copyright © Waverly Advisors, LLC 2013.Please review Disclosures on the final page of this report.
 
Macro Perspective:
China
 
In the wake of a weeklong holiday in China investors returned to markets last week to face a slew of new data points. Trade data released overnight Friday sharply disappointed, with a Y/Y contraction driven in part by softer demand fromemerging ASEAN economies. The week ahead will bring production, investmentand retails sales data for the month. For global risk markets the question is simply  whether the advances in activity measures can be sustained in the longer-term.Critically, Q3 GDP will be released on Thursday. In balancing longer-termheadwinds with current data, the following factors are paramount for portfoliopositioning:
 
Stable employment and rising wages suggest that personal consumption could well continue to expand at its current pace, even if the rate of GDP growthmoderates.
 
Real estate markets remain in bubble mode despite PBOC attempts at capitalflow controls.
 
Based on increased local media coverage it appears likely that Beijing ispreparing to initiate a disclosure regarding non-performing regional debt in thecoming months. Despite potentially huge numbers involved in a local debt vehicle write-down (some estimates breach 40% of GDP) it is likely that mostmarkets have largely priced this in.
 
Unlike the LGIV situation, markets are unprepared for a crisis in company-to-company lending markets. While there is no obvious signal of an impending crisis, it remains an outlier that warrants careful consideration.
 
Our tactical team's near-term analysis of Chinese large-cap Equities highlightsthat bearish patterns appear to be failing with bulls now in control.
 
 Although Hang Seng and Shanghai A share realized volatility measures remainroughly in line with those of the S&P 500, the realized and implied volatility measures for the FXI Chinese Equity ETF (the most liquid Chinese indexoption market in the US) has outpaced that of US stocks consistently. We conclude that there is no need to alter current allocations to Chinese Equities atthis time, but that selective investments focused on internal demand, rather thanproperty or external demand, may be poised to outperform from a macroperspective. For volatility traders, bullish short volatility measures may becomeattractive in a short-term swoon related to any announcements on LGIV exposuresor external macro events in the coming weeks.
Chinese ETPs: Higher Relative Volatility Regimes than US and Underlying MarketsStill in Bubble Territory 
 
0510152025303540455055ct 11Apr 12Oct 12Apr 13Oct 13DifferenceCBOE FXI Volatility IndexCBOE DJIA Volatility Index
source: Thomson Reuters 
 
909498102106110114118t 08Oct 09Oct 10Oct 11Oct 12Oct 13Newly Built -BeijingNewly Built -ShanghaiExisting -BeijingExisting -Shanghai
source: Thomson Reuters, National Bureau of Statistics 

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