This week in options. SPY, QQQ, Home Depot, Cisco and more.


The Broader Markets

Last Week – Better than expected inflation data helped to power the SPY +3.3% last week, more than the 1,7% move options were pricing. Implied volatility fell to its lowest levels since April, which is the only other time this year it has been this low.

This Week – SPY options are pricing a 1.4% move for the upcoming week.

Implied Volatility / VIX – The VIX closed the week near 19, down from 21 the week prior. VIX futures are steeply curved with December futures above 26 and Jan 2023 and beyond months above 27,

Expected Moves for This Week (via Options AI)

  • SPY 1.4% (+/- $6)
  • QQQ 2% (+/- $6.50)
  • IWM 2% (+/- $4)
  • DIA 1.3% (+/- $4.50)


In the News

The big story for markets last week was the strong continuation of the rally off the lows June lows and the prospects that we may have already seen peak inflation over the Summer. The S&P 500 is now more than 16% off the lows and is now just 10% from the highs. What a difference a few weeks make. With that, implied volatility has collapsed below 20 and now sits near the VIX historical mean. The fact that the bulk of earnings season is out of the way contributes to lower vol, and the markets seem to have a general sense of the Fed’s next few moves. As we saw last week that does not mean a boring market as it’s easier for stocks to outperform expected moves to the upside with vol lower. Which means options traders need to be more careful with credit spreads as expected moves can be close on the upside and reversals lower in the market would have the additional negative impact of quick spikes in IV.


Education

Last week we began with a brief intro on Iron Condors and Butterflies as income/neutral strategies. This week we’ll go a little more in depth on the differences.

Iron Condor

To look more closely at the Iron Condor, let’s use an example where XYZ stock is currently trading at $100. As a first step, we look at the Expected Move for our chosen expiration date. The options market is pricing a 3.0% move for the stock in the next 30 days. We do not disagree with this consensus and also have no strong view on whether the stock may move up or down in the time period. In other words, we believe that a move beyond 3% is relatively unlikely (the market is pricing it correctly) and our neutral view means that we are happy to sell to both Bulls (Call buyers) and Bears (Put buyers) to collect income if the stock stays within this range.

So, we open an Iron Condor by simultaneously selling a 103/104 Credit Call Spread (for $0.25 in premium) and a 97/96 Credit Put Spread (for $0.25 in premium). Therefore, in total we collect $0.50 in income. Since the width of each Credit Spread is $1 and we can only incur Max Loss on one Spread, our Max Gain is $0.50 and our Max Loss is $0.50 ($1 less $0.50).

By collecting a total premium of $0.50, our two Breakeven levels in this 96/97/103/104 Iron Condor become $103.50 to the upside and $96.50 to the downside. In other words, if the underlying stock price remains within this $96.50 – $103.50 range at expiration we will likely keep at least some of the income received and if the stock price remains within our short strikes ($97 – $103) we will likely keep all the income received and realize Max Gain on the position.

Iron Butterfly

To compare an Iron Butterfly to an Iron Condor, let’s again use an example where XYZ stock is currently trading at $100. Since both our short Call and Put will be at the same level, to take a neutral view, we set our center strikes at-the-money (at 100) and place our long Call and Put, or ‘wings’ at the expected move (103 and 97, respectively).

So, we open an Iron Butterfly by simultaneously selling a 100/103 Credit Call Spread (for $1.00 in premium) and a 100/97 Credit Put Spread (for $1.00 in premium). Therefore, in total we collect $2.00 in income. Since the width of each Credit Spread is $3 and we can only incur Max Loss on one Spread, our Max Gain is $2.00 and our Max Loss is $1.00 ($3.00 less $2.00).

By collecting a total premium of $2.00, our two Breakeven levels in this 97/100/100/103 Iron Butterfly become $102.00 to the upside and $98.00 to the downside. In other words, if the underlying stock price remains within this $98.00 – $102.00 range at expiration we will likely keep at least some of the income received. However, to realize Max Gain, we need the stock price to be precisely $100 at expiration and for neither our short Call or short Put to be assigned. This is a somewhat unlikely outcome, since even if the stock price is $100 at expiration, the significant assignment risk means that we will likely want to close the position rather than hold through expiry. 

And because the stock is unlikely to be exactly on the short strike, one of the two spreads will be in-the-money. Therefore a Max Gain on an Iron Butterfly is generally not the goal, nor realistic, as compared to an Iron Condor.

As a result, while the risk to reward ratio of an Iron Butterfly can be appealing (in comparison to an Iron Condor) realizing full Max Gain with this strategy can be relatively difficult. In addition, given that we are selling at-the-money rather than out-the-money options, overall capital requirements and Max Risk amounts can be significantly higher than using an Iron Condor to express a neutral view.

We’ll discuss the strengths of the Iron Butterfly in a later post.


Earnings

Links below go to the Options AI calendar where you can see the other companies each day and click through to see charts (free to use). Recent earnings moves (actual) start with the most recent:

Tuesday

  • Home Depot HD / Expected Move: 3.7% / Recent moves: +2%, -9%, +6%
  • Walmart WMT / Expected Move: 3.7% / Recent moves: -11%, +4%, +3%

Wednesday

  • Target TGT / Expected Move: 7.3% / Recent moves: -25%, +10%, -5%
  • Cisco CSCO / Expected Move: 4.8% / Recent moves: -14%, +3%, -6%
  • Lowes LOW / Expected Move: 4.9% / Recent moves: -5%, 0%, 0%

Thursday

  • Applied Materials AMAT / Expected Move: 4.8% / Recent moves: +4%, -3%, -5%

Friday

  • John Deere DE / Expected Move: 4.7% / Recent moves: -14%, -3%, +5%

Based upon publicly available information derived from option prices at the time of publishing. Intended for informational and educational purposes only and is not any form of recommendation of a particular security, strategy or to open a brokerage account. Options price data and past performance data should not be construed as being indicative of future results and do not guarantee future results or returns. Options involve risk, including exposing investors to potentially significant losses and are therefore not suitable for all investors. Option spreads involve additional risks that should be fully understood prior to investing. Securities trading is offered through Options AI Financial, LLC, member FINRA and SIPC.

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