Options Mispricing Snapshot - September 17, 2018

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Includes: IWM, QQQ, SPY
by: Denis Atamanov

Summary

SPY, QQQ, and IWM do not demonstrate enough steam to move higher after the break up their trading ranges and all-time highs.

Volatilty indices are fluctuating in the middle of their ranges of the recent months.

Options mispricing is back. The best opportunities are in the SPY puts (overpriced) and calls (underpriced).

Calls on SPY and QQQ look substantially underpriced that means the options market considers the potential upward move as not very probable.

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

Having broken up their trading ranges and all-time highs recently, all major equity indices do not demonstrate enough steam to move higher and seem to form another trading ranges instead. Volatility indices have been fluctuating around their normal levels of the recent months.

Options mispricing is back contrasting to the previous snapshot (September 4, 2018) when the most options series were priced fairly. The major changes happened in SPY and QQQ calls which flipped from the fairly priced to the substantially overpriced. The options market seems to estimate the further upward move as having very low probability.

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 the 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 has approached its all-time high again after a small correction in the last week; RSI(14) is in neither oversold nor overbought area.

VIX got back to the lows of the recent months reflecting the silent market:

SPY Expiration: September 28, 2018 (DTE 10)

Puts are priced fairly; calls are underpriced. Market prices are adjusted for the September 21 dividend ($1.23).

Source: Optionsmile.com

SPY Expiration: October 5, 2018 (DTE 15)

OTM puts are overpriced; ATM puts are priced fairly; calls are substantially underpriced. Market prices are adjusted for the September 21 dividend ($1.23).

Source: Optionsmile.com

SPY Expiration: October 12, 2018 (DTE 20)

OTM puts are substantially overpriced; ATM puts are overpriced not significantly; calls are substantially underpriced. Market prices are adjusted for the September 21 dividend ($1.23).

Source: Optionsmile.com

SPY Expiration: October 19, 2018 (DTE 25)

Puts are substantially overpriced; calls are substantially underpriced. Market prices are adjusted for the September 21 dividend ($1.23).

Source: Optionsmile.com

QQQ Snapshot

QQQ pulled back after the reaching its all-time high and looks like forming a new trading range; RSI(14) is fluctuating near the middle line of 50:

VXN demonstrates the silent market conditions overall:

QQQ Expiration: September 28, 2018 (DTE 10)

Puts are priced fairly; calls are substantially overpriced. Market prices are adjusted for the September 24 dividend ($0.308).

Source: Optionsmile.com

QQQ Expiration: October 5, 2018 (DTE 15)

Puts are priced fairly; calls are substantially underpriced. Market prices are adjusted for the September 24 dividend ($0.308).

Source: Optionsmile.com

QQQ Expiration: October 12, 2018 (DTE 20)

OTM puts are overpriced; ATM puts are priced fairly; calls are substantially underpriced. Market prices are adjusted for the September 24 dividend ($0.308).

Source: Optionsmile.com

QQQ Expiration: October 19, 2018 (DTE 25)

OTM puts are overpriced; ATM puts are priced fairly; calls are substantially underpriced. Market prices are adjusted for the September 24 dividend ($0.308).

Source: Optionsmile.com

IWM Snapshot

IWM has been hovering near the all-time high in the very narrow range; RSI(14) demonstrates neither overbought nor oversold conditions:

RVX is near its lows of the recent months reflecting the silent market conditions.

IWM Expiration: September 28, 2018 (DTE 10)

OTM puts are overpriced; ATM puts mispricing is not significant; calls are priced fairly. Market prices are adjusted for the September 26 dividend ($0.419).

Source: Optionsmile.com

IWM Expiration: October 5, 2018 (DTE 15)

OTM puts are overpriced; mispricing of calls and ATM puts is not significant. Market prices are adjusted for the September 26 dividend ($0.419).

Source: Optionsmile.com

IWM Expiration: October 12, 2018 (DTE 20)

OTM puts are substantially overpriced; ATM puts are priced fairly; calls are underpriced. Market prices are adjusted for the September 26 dividend ($0.419).

Source: Optionsmile.com

IWM Expiration: October 19, 2018 (DTE 25)

Both puts and calls are priced fairly. Market prices are adjusted for the September 26 dividend ($0.419).

Source: Optionsmile.com

Conclusion

Major opportunities can be found in overpriced puts on SPY, some OTM puts on QQQ and IWM, and calls on SPY and QQQ. Bullish risk reversals on SPY look attractive due to the substantial overpricing of puts combined with the underpricing of calls.

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.