Author's note: This is a new article in a regular series titled Options Mispricing Snapshot (see the previous report), 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. 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).
Equity markets look calming down after two volatile weeks of trading tensions between the US and trading partners. All major indices are recovering and the markets are calming down driving the volatility indices lower.
Put options are still overpriced, although not that substantially as in two previous weeks (see June 25 Snapshot); call options are also less underpriced than previously. Calls on IWM are mostly overpriced.
Mispricing summary for the options with two to five weeks until expiration:
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 6-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 SPY and QQQ, we apply auto filtering for Volatility index and RSI selecting 300 days in history with the shortest Euclidean distance to their current values. For IWM, we use manual filtering since the current regime is not typical due to the relatively low implied volatility (RVX index).
For each underlying, we select expirations on a range of 2-5 weeks and present options Fair Values and Market Prices, both historical (red line) and current real-time (green line). The market prices of these two types can sometimes diverge from each other if the current market condition (volatility surface) differs from its average state in the history.
SPY seems to be recovering after two volatile weeks of the trade war between the US and its trading partners, RSI(14) demonstrates neither oversold nor overbought condition.
SPY Expiration: July 20, 2018 (DTE 11)
Both puts and calls are mispriced just slightly, not statistically significant.
SPY Expiration: July 27, 2018 (DTE 16)
Puts are slightly overpriced; calls are underpriced.
SPY Expiration: August 3, 2018 (DTE 21)
Puts are substantially overpriced; calls are underpriced.
SPY Expiration: August 10, 2018 (DTE 26)
Puts are overpriced; calls are underpriced, both statistically significant.
QQQ also recovering from trade tensions turmoil; RSI(14) shows neither overbought nor oversold:
QQQ Expiration: July 20, 2018 (DTE 11)
QQQ Expiration: July 27, 2018 (DTE 16)
Puts are overpriced but not significantly; calls are substantially underpriced.
QQQ Expiration: August 3, 2018 (DTE 21)
QQQ Expiration: August 10, 2018 (DTE 26)
Puts are overpriced; calls are underpriced.
IWM is moving towards its all-time highs; RSI(14) is getting closer to the overbought condition:
RVX is also reflecting the calming market conditions.
IWM Expiration: July 20, 2018 (DTE 11)
Puts are priced fairly; calls are substantially overpriced:
IWM Expiration: July 20, 2018 (DTE 16)
OTM puts are overpriced, ATM puts are priced fairly; calls are substantially overpriced:
IWM Expiration: August 3, 2018 (DTE 21)
OTM puts are overpriced, ATM puts are priced fairly; calls are overpriced:
IWM Expiration: August 10, 2018 (DTE 26)
Both puts and calls are overpriced:
Major opportunities can still be found in overpriced puts and underpriced calls on SPY and QQQ. IWM calls and farther puts can be good candidates for selling.
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.