I follow 43 different ETFs that track equities (28), bonds (4), commodities (5), and currencies (6) and cover many different geographical area's. Everyone of these ETFs have options. Correlation, beta, and volatility (implied, historical, ATR) are my prime metrics. Relative value in options based on these metrics is what I am looking for.
SPY, QQQ, and DIA are all historically (52-week) and relatively high in implied volatility at the present time. When we compare how trader's are positioning themselves in the options market in these ETFs compared to international equity ETFs, both for developed and emerging markets, there are some glaring differences.
The fear that surrounds these 3 ETFs is the fiscal cliff. This fear is driving the premium for options higher, as occurs when traders bid up options (specifically put options for protection). It should be noted that IWM, the Russell 2000 Small Cap Index ETF is not experiencing the same violent lift in implied volatility as the other 3 major US index ETFs, though it is rising.
If we look at 2011 we will see that in August, when the US had its credit rating downgraded and we had another debt ceiling debacle, international equity ETFs had a major move in implied volatility along with US index ETFs. This is not the case today on the eve of the last day of this "fiscal cliff" debacle.
For instance, if we just take our neighbors to the north (Canada) and the south (Mexico) and look where implied volatility lies in the EWC, the Canadian equity ETF and the EWW, the Mexican equity ETF, we find that options are undervalued on a relative basis compared to the SPY. I like to look at both Canada and Mexico because they are our #1 and #3 trading partners and any economic disruptions we have will surely in some form or fashion affect those countries. The makeup of these ETFs will also matter but past performance reflects my point here.
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| SPY (left) and EWW (right) Implied Volatility |
If this truly is turning out to be another 2011, then it could be said that EWC and EWW options are still relatively cheap compared to SPY and if we do have a bearish bias on the (global) US market, than instead of paying a higher premium for put options in SPY, buying put options in EWW or EWC could be more valuable. Of course, reviewing the options skew is also critical but I won't cover that here.
What becomes interesting is that many international equity ETFs that are of +1 beta and are trending to make or have recently made new 52 week highs have very low implied volatility, in some cases both on a relative and historical basis. Also, many of these same ETFs experience greater lifts in implied volatility than the SPY during that same summer 2011 US credit downgrade period.
This begs the question if traders are too complacent or could this US event truly be an isolated one, meaning it won't have much impact outside of US boarders in equity markets? I have a tough time believing the latter, but I don't have to believe one way or another because in theory, I can play the differential in the implied volatility of different ETFs. For instances, I could sell puts in SPY while buying puts in EWC or EWW. Of course the correct weighting is essential in these types of scenario's.
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| EEM |
My belief is regardless of the fiscal cliff outcome (but maybe because of it) we will see a large move in global markets in 2013. A look back at volatility in 2012 (as posted last week) shows a major vol sell all year long across all major asset classes, irregardless of what region of the world the asset represents. All 43 ETFs I track have their short-term average true range (ATR) indicators below their long term ATR average, in many cases by 25% or greater. Looking at the EEM chart to the right, one can see the blue line (short term ATR) never crosses outside of the purple area (long term ATR) in 2012. The chart below shows the difference in percentage terms between an ETFs short term and long term ATR. Anything over 100% would indicate the ETFs short term ATR is greater than its long term ATR. As you can clearly see, not 1 of the 43 ETFs has that going for it (though some are close).
Finally, here is a look at the major implied volatility indices tracked by the CBOE. These are for the S&P 500 (VIX), the Russell 2000 Index (RVX), the EEM ETF (VXEEM), the Euro/US dollar exchange rate (EVZ), Gold (GVX), Silver ETF (VXSLV), and Crude Oil (OVX). There are IV indices for the NASDAQ and DJIA however I prefer to follow just the S&P 500 and R2K for beta purposes. There are two charts. The first chart is implied volatility performance for 2012 in percentage terms and the second is a 3-month view of implied volatility performance in percentage terms. As one can see, the VIX has significantly outperformed the rest of the implied volatility indices with its recent run higher. The question I ask myself is do people really believe that even if we go over the fiscal cliff, we are going to have a big sell off? Instead, what it feels like to me is that traders do not believe this will be the end result however don't want to get blown out of the water if it turns out otherwise, especially at the beginning of the year. These positions (buying SPX, SPY puts) are not a symptom of bulls turning bearish but rather staying net long and buying puts for portfolio protection.
I do not have a bias in the equity markets, instead I am intently focused on options in ETFs which are cheap on a relative and historical basis. Any positive or negative news could spill over to those options which are not bid up, quickly elevating option premiums. This is what I am betting on.
In summary, many are eyeballing the VIX and SPX/ SPY options. I too am eyeballing these options but for the opposite reasons. If I was to enter in any trade involving these options it would be to SELL these premiums and use those proceeds to buy cheaper options in other "risk on", higher beta ETFs.
'Til next time...
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