Options Mispricing Snapshot – October 15, 2018


UNDERLYINGS:
FILTERS:
TIME:
October 15, 2018 10:00 ET (New York)

SUMMARY

Volatility is back. It has returned the way it happened just a couple of times in the last years, quite abruptly. Equity markets suffered a sharp selloff last week, volatility indices jumped to the levels last seen in April this year.  

All equity indices entered the oversold domain. Historically speaking, the probabilities of bouncing back are much higher than the continuation of the fall as the macroeconomic conditions look solid (although, high price volatility ahead is guaranteed). That expected move and the inflated IV make put options hugely overpriced and calls underpriced across all the underlyings and expirations.

Here is the mispricing summary for the series with 2, 4, and 6 weeks until expiration:

    Puts  Calls
OTM ATM ATM OTM
SPY

2 weeks

Overpriced substantially

Underpriced

4 weeks

Overpriced substantially

Underpriced substantially

6 weeks

Overpriced

Underpriced substantially
QQQ 2 weeks

Overpriced substantially

Underpriced 

4 weeks

Overpriced substantially

Underpriced

6 weeks

Overpriced substantially

Underpriced substantially

IWM 2 weeks Overpriced Underpriced

4 weeks

Overpriced substantially

Underpriced substantially

6 weeks

Overpriced substantially

Underpriced substantially

For those who can withstand huge volatility, overpriced put options can provide good opportunities to sell (with proper tail hedging, solid money management, and position sizing). Despite the inflated implied volatility, calls options are good for buying as the historical distribution indicates the high probability of the upward bounce.

Market regime Filtering

To make our estimation more reliable, we filter the historical data and select from the past only those dates when the market resembled the current condition (read more here). We use three filters:

  • Long-term macroeconomic regime. We filter out the recessionary environment (or looming recession) with The Conference Board Leading Economic Index® (LEI) and select all dates when its 6-month rate-of-change was above -2%.
  • Volatility regime. We use VIX, VXN, and RVX indices as volatility filters for SPY, QQQ, and IWM respectively.
  • Short-term swing regime. We use Relative Strength Index (RSI) with 14-days interval - RSI(14)

For SPY and QQQ, we apply auto filtering for Volatility index and RSI selecting 300 days in history with the shortest Euclidean distance to their current values. For IWM, we use manual filtering.

For each underlying, we select expirations on 2, 4, and 6 weeks and present options Fair Values and Market Prices, both historical (red line) and current real-time (green line). The market prices of these two types can sometimes diverge from each other if the current market condition (volatility surface) differs from its average state in the history. 

SPY snapshot

SPY has dropped sharply and entered the oversold area according to RSI(14).

VIX surged to its highs since April this year:

 

SPY Expiration: October 26, 2018 (DTE 10)

Puts are substantially overpriced; calls are underpriced. 

 

SPY Expiration: November 9, 2018 (DTE 20)

Puts are substantially overpriced; calls are substantially underpriced. 

 

SPY Expiration: November 23, 2018 (DTE 29) 

Puts are overpriced; calls are substantially underpriced.

 

QQQ Snapshot

QQQ has also dropped sharply and entered the oversold area:

VXN has jumped to its highs since April this year:

 

QQQ Expiration: October 26, 2018 (DTE 10)

Puts are substantially overpriced; calls are underpriced.

 

QQQ Expiration: November 9, 2018 (DTE 20)

Puts are substantially overpriced; calls are underpriced. 

 

QQQ Expiration: November 23, 2018 (DTE 29)

Puts are substantially overpriced; calls are substantially underpriced. 

 

IWM snapshot

IWM has actually formed a local downtrend having lost more than 10% in a couple of weeks RSI(14) demonstrates an extremely oversold condition not seen for a long time:

RVX in its highs as it usually happens in such a market.

 

IWM Expiration: October 26, 2018 (DTE 10)

Puts are overpriced;  calls are underpriced. 

 

IWM Expiration: November 9, 2018 (DTE 20)

Puts are substantially overpriced;  calls are substantially underpriced. 

 

IWM Expiration: November 23, 2018 (DTE 29)

Puts are substantially overpriced;  calls are substantially underpriced. 

 

The information provided on this Website is for informational purposes only and should not be considered as an investment advice. It is not intended to replace consultation with a qualified financial professional. Investing in options involves risk of potential loss exceeding the whole amount of money invested. No one should make any investment decision without first consulting his or her own financial advisor and conducting his or her own research and due diligence.