The recent developments in Iraq have nudged options volatility higher, but for one underlying, SVXY, it has apparently pushed IV through the roof. This development has brought about some potentially profitable option spread possibilities.Terry
An Interesting Trade to Make on Monday
In case you don’t know what SVXY is, you might check out the chart of its volatility-related inverse, VXX. This is the ETP many investors use as a protection against a market crash. If a crash comes along, options volatility skyrockets, taking VXX right along with it. The only problem with VXX is that over time, it is just about the worst investment you could imagine making. Three times in the last five years they have had to engineer 1 – for – 4 reverse splits to keep the price higher enough to bother with buying. Over the past 7 years, VXX has fallen from a split-adjusted price over $2000 to its current $32.
Wouldn’t you like to buy the inverse of VXX? You can. It’s called SVXY (XIV is also its inverse, but you can’t trade options on XIV).
Last week I talked about buying short-term (weekly) call options on SVXY because in exactly half the weeks so far in 2014, the stock had moved $4 higher at least once during the week. I also advised waiting until option prices were lower before taking this action. Now that option prices have escalated, the best thing seems to be selling option premium rather than buying it.
Two weeks ago, a slightly out-of-the-money weekly SVXY option had a bid price of $1.05. Friday, that same option had a bid price of $2.30, more than double that amount.
All other things being equal, SVXY should move higher each month at the current level of Contango (6.49%). That works out to about $1.20 each week. I would like to place a bet that SVXY moves higher by about that amount and sell a calendar spread at a strike price about that much above Friday’s close ($79.91).
Below I have displayed the risk profile graph for a July-June 81 calendar put spread (I used puts rather than calls because if the stock does move higher, the June puts will expire worthless and I will save a commission by not buying them back.
This would be the risk profile graph if we were to buy 5 Jul-14 – Jun-14 put calendar spreads at the 81 strike price at a cost of $3.00 (or less). You would have $1500 at risk and could make over 50% on your investment if the stock goes up by amount that contango would suggest. Actually, as I write this Monday morning, it looks like SVXY will open up about a dollar lower, and the spread might better be placed at the 80 strike instead of the 81.
A break-even range of $3 to the downside and about $5 on the upside looks quite comfortable. If you had a little more money to invest, you might try buying September puts rather than July – this would allow more time for SVXY to recover if it does fall this week on scary developments in Iraq (or somewhere else in the world).
I have personally placed a large number of Sep-Jun calendar spreads on SVXY at strike prices both above and below the current stock price in an effort to take advantage of the unusually higher weekly option prices that exist right now.
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