Options Mispricing Snapshot - April 23, 2018

Apr. 24, 2018 6:16 PM ETSPY, QQQ, IWM8 Comments
Denis Atamanov profile picture
Denis Atamanov
541 Followers

Summary

  • Equity markets are staying within the range formed in the last several months.
  • Implied Volatility is slightly elevated, no short-term oversold/overbought condition observed.
  • Call options are priced almost fairly my the market except for QQQ.
  • Put options are mostly overpriced with maximum overpricing in QQQ.

Author note: This is the first article in a new regular options market series, titled Options Mispricing Snapshot, in which we will compare current market prices of options to their fair values for three major ETFs on U.S. equity indices: SPY, QQQ, and IWM. All metrics are calculated using the OptionsSmile platform (see methodology description here).

Using the data provided here, long equity investors who use option strategies such as covered calls, protective puts, collars, etc. - to either protect their portfolios or earn additional income (or both) - can figure out what effects, positive or negative, their option "overlays" have on the total portfolio returns. In other words, an investor can estimate the real cost of portfolio insurance with put options and find out if their covered calls really earn additional income to their holdings (see an example here).

Summary

All major equity indices have recovered from the recent correction and bounced back from their support levels. Neither an oversold nor overbought condition is observed as RSI(14) is hovering around the 50 level. Volatility has gotten back to normal and the markets are overall normalizing. Option market prices have moved closer to their fair values (puts are less overpriced, calls are valued mostly fairly) except for QQQ, where mispricing remains substantial.

Here is a mispricing summary for options with two to five weeks until expiration:

Puts Calls
OTM ATM ATM OTM
SPY Overpriced Fairly priced Fairly priced Fairly priced
QQQ Overpriced substantially Overpriced substantially Underpriced substantially Underpriced
IWM Overpriced substantially Overpriced Fairly priced Fairly priced

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 six-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 each underlying, we select expirations in a range of two to five weeks. We present mispricing charts for each expiration and basic PL metrics for the best one-leg strategy (buying or selling puts or calls) measured by the expected profit (annualized).

SPY Snapshot

SPY has recovered almost one-third of the recent 10% correction. RSI(14) level of around 50 shows no oversold condition anymore.

Source: Stocksharts

Expiration: May 4, 2018 (DTE 10)

Puts are overpriced; calls overpricing is not statistically significant:

Source: Optionsmile.com

Expiration: May 11, 2018 (DTE 15)

OTM (out of the money) puts are overpriced; the mispricing of ATM (at the money) puts and calls is not statistically significant:

Source: Optionsmile.com

Expiration: May 18, 2018 (DTE 20)

OTM puts are overpriced; ATM puts are priced fairly; calls mispricing is not statistically significant:

Source: Optionsmile.com

Expiration: May 25, 2018 (DTE 25)

OTM puts are overpriced; ATM puts are priced fairly; calls mispricing is not statistically significant:

Source: Optionsmile.com

The Best One-Leg Strategy

Short put PL metrics for May 4 expiration:

Source: Optionsmile.com

QQQ Snapshot

As with SPY, QQQ has also recovered after the February-March sell-off. RSI(14) level of around 50 shows there is no oversold condition anymore:


Source: Stockcharts

Expiration: May 4, 2018 (DTE 10)

Puts are substantially overpriced; calls are underpriced, but not very significant:

Source: Optionsmile.com

Expiration: May 11, 2018 (DTE 15)

Puts are overpriced; calls are underpriced - all very significant:

Source: Optionsmile.com

Expiration: May 18, 2018 (DTE 20)

Puts are overpriced; calls are underpriced - all very significant:Source: Optionsmile.com

Expiration: May 25, 2018 (DTE 25)

Puts are overpriced; calls are underpriced - both very significant:

Source: Optionsmile.com

The Best One-Leg Strategies:

Short put PL metrics for May 11 expiration:

Source: Optionsmile.com

Long call PL metrics for May 25 expiration:

Source: Optionsmile.com

IWM Snapshot

IWM has recovered more than a half of its recent correction. RSI(14) demonstrates neither oversold nor overbought condition:

Source: Stockcharts

Expiration: May 4, 2018 (DTE 15)

Puts are overpriced mostly OTM; calls are priced almost fairly:

Source: Optionsmile.com

Expiration: May 11, 2018 (DTE 14)

OTM puts are substantially overpriced; ITM puts are also overpriced but not statistically significant; calls are priced almost fairly:

Source: Optionsmile.com

Expiration: May 18, 2018 (DTE 19)

Puts are overpriced mostly OTM; calls are underpriced but not statistically significant:

Source: Optionsmile.com

Expiration: May 25, 2018 (DTE 24)

Puts are overpriced mostly OTM; calls are priced almost fairly:

Source: Optionsmile.com

The Best One-Leg Strategy:

Short put PL metrics for May 4 expiration:

Source: Optionsmile.com

Conclusion

According to our analysis, the premium harvesting opportunity can be found in put options, especially in QQQ. Call options are priced quite fairly and selling or buying then would not add much to the portfolio income in terms of expected profit/loss. Any call overwriting for QQQ would pose a drag to the portfolio return since QQQ call options are overpriced in this market regime.

Disclaimer: The information provided in this article is for informational purposes only and should not be considered as an investment advice. Investing in options involves risk of potential loss exceeding the whole amount of money invested. Fair Value of an option is a mathematical expectancy meaning that the expected profit or loss will not realize in each particular trade. It is based on the past performance of the underlying security, which is not guaranteed in the future. I use the approach of the options fair value estimation and finding the market mispricing in my daily trading.

This article was written by

Denis Atamanov profile picture
541 Followers
I am an investment advisor and option trader.Before 2014, I worked in the pension industry for 7 years being responsible for the asset management function as a Vice President on Investments of a private pension fund (around $1 billion AuM). Since 2014, I have been working as an investment advisor with my own private practice focusing on the long-term portfolio management with index ETFs and hedging with options. The other part of my professional life is options trading. I have been familiar with it for the last decade, and now I trade them on a daily basis using options to build trading strategies or as a hedge for the long-term equity positions in my portfolios and portfolios of my clients. In 2017, I decided to open to the public my software that I had been developing and using for myself for several years. I called it OptionSmie - www.optionsmile.com. It is an online analytical software platform calculating the options Fair Value on the basis of the historical distribution of the underlying security. It identifies market misprising and discovers trading opportunities in different market regimes and helps in building options trading or hedging strategies. Since it is a by-product of my own trading that I use every day, I decided to make the access free because the incremental cost for making it public is not material for me. What is more valuable is the feedback that I’m receiving to my approach, which is somewhat unusual and is not widely used among option traders.
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Disclosure: I am/we are long SPY, QQQ, IWM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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