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).
SPY and QQQ are fluctuating near their all-time highs while IWM has retreated from the levels reached in the late August. Volatility indices do not demonstrate any stress except for the RVX which reflects the recent pullback of IWM.
Options on SPY and QQQ demonstrate the typical mispricing in a silent market: puts are overpriced, calls are either underpriced or fairly priced. Meanwhile, IWM put options are in a quite unusual position: despite the oversold condition and elevated implied volatility (RVX), they do not look overpriced. Perhaps, it is the influence of the overall silence in the equity markets.
Starting from this report, we will be analyzing three expiration series instead of four: with 2, 4, and 6 weeks until expiration. Here is the mispricing summary:
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.
For each underlying, we select expirations on 2, 4, and 6 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 has been hovering near its all-time high; RSI(14) is in neither oversold nor overbought area.
VIX is near its lows of this year:
SPY Expiration: October 12, 2018 (DTE 9)
OTM puts are overpriced; ATM puts are priced fairly; calls are underpriced.
SPY Expiration: October 26, 2018 (DTE 19)
OTM puts are substantially overpriced; ATM puts are overpriced; calls are underpriced.
SPY Expiration: November 9, 2018 (DTE 39)
Puts are substantially overpriced; calls are underpriced.
QQQ has once again reached its all-time high level; RSI(14) shows neither oversold nor overbought condition:
VXN is placed in the middle of the last month's range:
QQQ Expiration: October 12, 2018 (DTE 9)
Puts are priced fairly; calls are slightly underpriced.
QQQ Expiration: October 26, 2018 (DTE 19)
OTM puts are overpriced; ATM puts are priced fairly; calls are priced fairly.
QQQ Expiration: November 9, 2018 (DTE 39)
IWM has retreated from its August highs; RSI(14) has moved to the oversold area:
RVX is somewhat elevated reflecting the recent decline in IWM.
IWM Expiration: October 12, 2018 (DTE 9)
Puts are priced fairly; calls are underpriced.
IWM Expiration: October 26, 2018 (DTE 19)
Puts are priced fairly; calls are substantially overpriced.
IWM Expiration: November 9, 2018 (DTE 39)
Puts are overpriced; calls are substantially underpriced.
Major opportunities can be found in overpriced puts on SPY and QQQ. Calls on SPY and IWM are mostly underpriced which makes them 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, 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.