Options Mispricing Snapshot - May 7, 2018

Summary

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

Option prices have been keeping their move to fair values leaving less mispricing opportunities.

Overall, the options market is getting back to normal: puts are overpriced (mostly OTM), calls are priced fairly.

Opportunities in QQQ persisting in the previous weeks have almost gone.

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 have been fluctuating within the recent months’ range toward the end of the earnings season. RSI(14) was again hovering slightly above 50 mark showing neither oversold nor overbought condition.

Option prices have been keeping their move to fair values leaving less mispricing opportunities. Overall, the options market is getting back to normal: puts are overpriced (mostly OTM), calls are priced fairly.

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 Fairly priced Fairly priced Fairly priced
IWM

Overpriced substantially

Fairly priced

Fairly priced Fairly priced

Market Regimes 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 been staying within the range 260-270 again; RSI(14) level of around 50 shows no oversold condition.

Source: Stockcharts

VIX remains close to the lower band of the range of the last months:

Source: Stockcharts

SPY Expiration: May 18, 2018 (DTE 10)

Both puts and calls are fairly priced:

Source: Optionsmile.com

SPY Expiration: May 25, 2018 (DTE 15)

Puts are overpriced but not substantially; calls are priced fairly:

Source: Optionsmile.com

SPY Expiration: June 1, 2018 (DTE 19)

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

Source: Optionsmile.com

SPY Expiration: June 8, 2018 (DTE 24)

Puts are substantially overpriced; calls are priced fairly:

Source: Optionsmile.com

The Best One-Leg Strategy

Short Put PL metrics for June 8 expiration:

Source: Optionsmile.com

QQQ Snapshot

QQQ has jumped to its upper band of the recent range driving RSI(14) closer to 60 level:

Source: Stockcharts

VXN continued its way down reflecting the diminishing QQQ options IV:

Source: Stockcharts

QQQ Expiration: May 18, 2018 (DTE 10)

Puts are overpriced calls are underpriced but not substantially:

Source: Optionsmile.com

QQQ Expiration: May 25, 2018 (DTE 15)

Mispricing of puts and calls is not statistically significant:

Source: Optionsmile.com

QQQ Expiration: June 1, 2018 (DTE 19)

Puts are significantly overpriced only OTM; calls are priced fairly:

Source: Optionsmile.com

Expiration: June 8, 2018 (DTE 24)

Puts are significantly overpriced only OTM; calls are priced fairly:

Source: Optionsmile.com

The Best One-Leg Strategy:

Short Put PL metrics for June 8 expiration:

Source: Optionsmile.com

IWM Snapshot

IWM has moved higher but remains below highs of the recent months. RSI(14) demonstrates neither oversold nor overbought condition:

Source: Stockcharts

RVX remains near the lows of the recent months:

Source: Stockcharts

IWM Expiration: May 18, 2018 (DTE 10)

Both puts and calls are overpriced but not significantly:

Source: Optionsmile.com

IWM Expiration: May 25, 2018 (DTE 15)

OTM Puts are substantially overpriced, ITM puts are priced fairly; calls are overpriced but not significantly:

Source: Optionsmile.com

IWM Expiration: June 1, 2018 (DTE 19)

Puts are overpriced mostly OTM; calls are overpriced but not significantly:

Source: Optionsmile.com

IWM Expiration: June 8, 2018 (DTE 24)

Puts are overpriced mostly OTM; calls are overpriced but not significantly:

Source: Optionsmile.com

The Best One-Leg Strategy:

Short Put PL metrics for June 1 expiration:

Source: Optionsmile.com

Conclusion

Opportunities in QQQ persisting in the previous weeks have almost gone; just OTM puts remain overpriced. Overall, some interesting mispricing is observed only in the OTM puts area for all three indices.

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, IWM, QQQ. 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.