Last week was an interesting one to say the least.
After the release of the FOMC minutes from their last meeting traders were shocked that it appeared that there would be no QE III. If you're just joining us here on our planet from Mars, QE means 'quantitative easing' or the U.S. printing presses working non-stop to add 'liquidity' to the market. They're also off by a number, technically this would be QE IV but who's counting? We're all paying for it.
We at Top Gun Options believe the market is apparently suffering from short term memory loss. Fed Chairman Bernanke said, or more to the point, did not say there would be another round of QE when he testified in front of Congress last month. The market feigned shocked, pulled back, volatility rose, and then…nothing. The market resumed its upward trajectory guided by the 'invisible hand of the Fed'. Our actually, the quite visible helicopter flown by Big Ben himself.
So it's almost comical that the market has reacted to the 'new news' this week that the bartender has finally said "Last call!". Apparently they did not hear him the first time he said it, didn't believe him, or are now starting to feel the effects of a hangover. Welcome to the way 'smart people' trade in this market. As a former retail trader I know this can be extremely frustrating - it's counter intuitive. Or not.
Add to this news a rocket attack on Israel out of Egypt and it's enough to make your head spin. Or more to the point as an options trader wonder why volatility is so low.
This week our volatility barometer, the CBOE Volatility Index (VIX), woke up from its slumber of $15 and nearly hit $18 yesterday (gasp!) and we're hovering around $16ish. Yawn…
The last time we saw a 'spike', if a bump can be called that, in volatility was when the Fed chief testified in front of Congress. But then he went on a college tour like Tosh.O and reassured the nation that the party wasn't going to end and he was buying the next round.
So where does this leave us?
At Top Gun Options, we're overall market neutral. Now to the uninitiated that sounds like voting 'present' but it's not. We employ tactics, not strategies, that take advantage of a market neutral strategic mindset. Why? Because no one can predict what the right side of a chart will look like and look at a chart is like driving in a NASCAR race looking in the review mirror. Not smart. Unless you're Ricky Bobby.
So our being market neutral also leads us to the ability to be long term bullish on volatility while being short term bearish. We currently have a position in our skill based Primary Model Portfolio that is called a Diagonal on the iPath S&P 500 VIX short term futures (NYSEARCA:VXX). We bought deep in the money calls with a .8 delta that expire in January 13 while selling front month calls to the upside to help finance this call purchase. Initially we sold the 25's and vol has not really spike at all on the news this week so we bought back those short calls and rolled them down to the 20 strike. The mission objective is to 'not fight the tape' or 'not fight the Fed' for that matter and follow the flow of that market which is singing "Kumbaya" around the fire place with a sweater while drinking and glass of Chardonnay.
Something has to give. Domestically unemployment remains above 8%, more and more people are upside down on their homes and choosing to strategically default, the Fed is putting our children deeper into debt literally by the second, we don't have a budget (going past 1,000 days by the way), and oh by the way there's an election in November.
Across the pond rockets are raining on Israel and it's not a matter of if but when they will attack Iraq. Spain saw national protests this week and may have caught something from Greece…you gotta be careful when you party too hard in Ibizza…not that I'm speaking from experience… China is attempting to slam on the brakes, learning from the hard lessons of the U.S. financial train wreck. So when our banker decides the parties over, we could be in some deep…stuff.
Where's this leave us? Short term bearish on volatility while having an insurance policy for when we wake up one day and see smoke on the TV coming out of Tehran or Iranian corvettes stringing mines across the Straight or Hormz.
On Thursday we also placed a neutral trade on Gold via the GLD. Seen as a 'flight to safety' the precious metal is popular with not only the 'guns, water, ammo, cabin in Montana' crowd, but with the rest of the world as well. China and India are buying tons upon tons of physical gold like you read about in 'Buying Tons of Gold' magazine.
The trade we placed was an April 151/155/165/169 Iron Condor that has a 70% probability of achieving max profit ($2300) by April expiration 16 days from now.
Bottom line - now is the time to keep you powder dry and avoid directional tactics. Volatility will return to this market, somehow, someway, and you need to be ready. Remember - the market can stay irrational longer than you can stay solvent. By employing market neutral tactics like Diagonals and Iron Condors you can stack probability in your favor and potentially come out on top. Trading is combat. Don't end up getting destroyed.
Additional disclosure: We are long the VXX and GLD positions in our Primary Model Portfolio.