OPTIONS: Is Implied Volatility Underpriced?

Once again, the Euro Zone is engaged in talks. This time, there are many more substantial topics related to budget harmony to help tamp down the issues that have plagued the last three years.

GOING NOWHERE
The U.S. equity markets really do not seem to know where to go. Apple (AAPL) hit 700, and Google (GOOG) is trading at all-time high. There is a sense that nothing much is going to happen. The leaders have led higher, but that has not really generated anything exciting, since the Fed opened the flood gates not very long ago.

SNOOZE FEST
The S&P 500 (SPX) is currently trading up 3.6 to 1460.22, and the VIX is screaming up .02 to 14.17. The only trades that really have worked have been the short gamma type trades that generate positive theta to help get through our snooze fest (see last week's analysis here).

GET READY
The more interesting news of note for the volatility products is that the VXX (one of our favorite products to sell) is going to split 1 for 4 (reverse) October 5. The VXX has split several times due to its dependence on long VIX future premiums that decay month after month. Hopefully, the name will get more interesting after the split, but for now, traders should exit the product before the gamma crushing 1 for 4 reverse split (gamma will reduce by 16x) consumes the options. Look again to position after October 5.

SHORT TERM PLAY
A trade that looks interesting to me is shorter term option buying in the CurrencyShares Euro Trust (FXE). With the negotiations going on and some news on Spain due out Friday, the Euro can easily see some short term highs on speculation that a deal goes through to harmonize budgets (especially if the Germans buy in).

The October cycle is trading for around 8.5% volatility, and with the recent moves, I think that implied volatility is a bit underpriced. Skew a long strangle in Oct to buy a long ATM call and an OTM put in case disaster befalls the talks.

Read our daily Markets section for more trading ideas here.

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