Seeking Alpha

Options Mispricing Snapshot - April 30, 2018

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Includes: IWM, QQQ, SPY
by: Denis Atamanov
Summary

Equity markets remain rangebound, staying within the range of last months.

Options markets are calming down driving prices of put options closer to their fair values and making call options increasingly underpriced.

The best opportunities remain in QQQ: selling puts, buying calls (bullish risk reversal).

Author note: This is the second article in a new regular options market series, titled Options Mispricing Snapshot, in which we compare current market prices of options to their fair values for three major ETFs on U.S. equity indices: SPY, QQQ, and IWM. The previous report is located here. 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 three indices finished the last week almost unchanged, again. Overall, they remain almost in the middle of the range formed in recent months. RSI(14) is still hovering around 50 mark showing neither oversold nor overbought condition.

Meanwhile, the option pricing picture has changed somewhat. Especially in the near-term expirations where prices of put options have moved closer to their Fair Values and made them priced almost fairly (for SPY and IWM).

Overall, options market seems to calm down and is coming to normal. The same force has driven the call prices down making them mostly underpriced.

Mispricing summary for the options with two to five weeks until expiration:

Puts Calls
OTM ATM ATM OTM
SPY

Near-term expirations – Fairly priced

Farther expirations – Overpriced substantially

Fairly priced Fairly priced
QQQ Overpriced substantially Overpriced Underpriced substantially Underpriced
IWM

Near-term expirations – Fairly priced

Farther expirations – Overpriced

Underpriced Underpriced

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 finished the previous week almost unchanged again; RSI(14) level of around 50 shows no oversold condition.

Source: Stocksharts

VIX is close to its lows since February: Source: Stocksharts

Expiration: May 11, 2018 (DTE 10)

Both puts and calls are priced almost fairly:

Source: Optionsmile.com

Expiration: May 18, 2018 (DTE 15)

Puts are overpriced but not substantial; the mispricing of calls is not statistically significant:

Source: Optionsmile.com

Expiration: May 25, 2018 (DTE 20)

Puts are overpriced, especially OTM; calls are priced fairly:

Source: Optionsmile.com

Expiration: June 1, 2018 (DTE 24)

Puts are substantially overpriced; calls are underpriced but not statistically significant:

Source: Optionsmile.com

The Best One-Leg Strategy

Short Put PL metrics for June 1 expiration:

Source: Optionsmile.com

QQQ Snapshot

As with SPY, QQQ has also slightly changed for the week. RSI(14) level of around 50 shows there is neither oversold nor overbought conditions.

Source: Stocksharts

VXN also has not changed significantly for the week:

Source: Stocksharts

Expiration: May 11, 2018 (DTE 10)

Put prices have moved closer to their average historical prices (green and red lines coincide) and remain substantially overpriced; calls are underpriced:

Source: Optionsmile.com


Expiration: May 18, 2018 (DTE 15)

Puts are overpriced; calls are substantially underpriced:

Source: Optionsmile.com


Expiration: May 25, 2018 (DTE 20)

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

Source: Optionsmile.com

Expiration: June 1, 2018 (DTE 24)

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

Source: Optionsmile.com

The Best One-Leg Strategy:

Short Put PL metrics for May 25 expiration:

Long Call PL metrics for May 25 expiration:

Source: Optionsmile.com


IWM Snapshot

IWM has also slightly changed for the week. RSI(14) demonstrates neither oversold nor overbought condition:

Source: Stochcharts

RVX is testing its lows for the last months:

Source: Stochcharts

Expiration: May 11, 2018 (DTE 15)

Puts are priced almost fairly; calls are underpriced:

Source: Optionsmile.com

Expiration: May 18, 2018 (DTE 15)

Puts mispricing is not statistically significant; calls are underpriced:

Source: Optionsmile.com


Expiration: May 25, 2018 (DTE 20)

Puts are overpriced mostly OTM; calls are underpriced:

Source: Optionsmile.com

Expiration: June 1, 2018 (DTE 24)

Puts are overpriced mostly OTM; calls are fairly priced:

Source: Optionsmile.com

The Best One-Leg Strategy:

Short Put PL metrics for June 1 expiration:

Source: Optionsmile.com

Conclusion

According to this analysis, interesting opportunities remain in QQQ where puts are still substantially overpriced and calls are underpriced (bullish risk reversal strategy). Among SPY options, the only opportunity remains is selling puts with farther expirations (20-25 trading DTE). IWM has just opened an opportunity for calls buying.

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.

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.