Options Mispricing Snapshot - August 7, 2018

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

All major equity indices have been hovering near their all-time highs.

Volatility indices have dropped to their lows as earnings season is over.

The options market is its typical condition: puts are mostly overpriced, calls are either priced fairly or slightly underpriced.

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. Fair values 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 are still at their all-time highs, volatility indices have dropped after the end of the earnings season.

As in a typical market condition, put options are mostly overpriced while call options are either underpriced or priced fairly.

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 Snapshot

SPY is near its all-time highs; RSI(14) has moved closer to the overbought condition.

VIX is at its lows since the beginning of the year reflecting the silent market:

SPY Expiration: August 17, 2018 (DTE 9)

Puts are overpriced but not significantly; calls are underpriced.

Source: Optionsmile.com

SPY Expiration: August 24, 2018 (DTE 15)

Puts are substantially overpriced; calls are underpriced.

Source: Optionsmile.com

SPY Expiration: August 31, 2018 (DTE 19)

Puts are overpriced especially in the OTM area; calls are underpriced.

Source: Optionsmile.com

SPY Expiration: September 7, 2018 (DTE 23)

Puts are substantially overpriced; calls are substantially underpriced.

Source: Optionsmile.com

QQQ Snapshot

QQQ has survived the recent tech stocks turmoil and returned to its all-time highs; RSI(14) has moved closer to the overbought condition:

VXN is at its lows after the volatile earnings period:

QQQ Expiration: August 17, 2018 (DTE 9)

Puts are priced fairly; calls are slightly underpriced.

Source: Optionsmile.com

QQQ Expiration: August 24, 2018 (DTE 14)

Puts are overpriced; calls are underpriced but not very significantly.

Source: Optionsmile.com

QQQ Expiration: August 31, 2018 (DTE 19)

Puts are overpriced; calls are underpriced but not very significantly.

Source: Optionsmile.com

QQQ Expiration: September 7, 2018 (DTE 23)

Puts are overpriced; calls are underpriced but not very significantly.

Source: Optionsmile.com

IWM Snapshot

IWM has been staying in the range of the last months; RSI(14) shows neither overbought nor oversold condition:

RVX is reflecting the silent market conditions.

IWM Expiration: August 17, 2018 (DTE 9)

Both puts and calls are priced fairly:

Source: Optionsmile.com

IWM Expiration: August 24, 2018 (DTE 14)

Puts mispricing is not significant; calls are just slightly underpriced:

Source: Optionsmile.com

IWM Expiration: August 31, 2018 (DTE 19)

OTM puts are substantially overpriced; ATM puts are priced fairly; calls are underpriced:

Source: Optionsmile.com

IWM Expiration: September 7, 2018 (DTE 23)

OTM puts are overpriced; ATM puts are priced fairly; calls are underpriced:

Source: Optionsmile.com

Conclusion

Major opportunities can be found in overpriced puts on SPY and OTM puts on QQQ and IWM. Call options on SPY with farther expirations are good candidates for 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, 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.