The market is trying to digest the possibility of a deal on the deficit by Christmas. For most market watchers and investors that should play out to be a more bullish theme for the New Year. I am not going to try and forecast the chance of the deal being done but it seems now both sides are looking a little at the middle of the road and concluding things are not so bad. The business community could only be so lucky. Here is how I think things shape out to the end of the year.
OPTIONS UPDATE
The Volatility Index (VIX) is still trading at a robust level given the current state of realized volatility in most of the indexes. The S&P 500 (SPX) is trading around 8.2% on 10 day realized volatility. The VIX which looks at mid-January is still in the 16 handle at 16.25 but it is defying gravity right now. The market is pricing in a good size move coming just after the holiday. The more conciliatory the news is the higher the market goes. Even the Dec Ordinary SPX has an ATM volatility of 14%. The market is pricing things to move but in the meantime we are stuck with expensive options.
HOW TO PLAY
The trade idea is really a riff on short term activity. I don’t see a huge range of action until the end of the week but the options are still pretty expensive.
So for Dec expiring this week in the SPDR S&P 500 ETF (SPY) I would sell the 142.5/143 put spread for .20 and work into selling a higher call spread like the 145/145.5 for .18. A little work and you can have the short modified SPY Dec Iron Butterfly for .38 with .12 of risk. While the IV is expensive, keep the short gamma risk relatively small.
[Editor’s note: Just getting started in options? Post a comment or question for Giovinazzi below.]
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