The SPX is right back to rallying after taking a day off to remind the public it can drop a standard deviation in a day if it feels like it. In the process the VIX gave back almost the entire gain from yesterday. We are getting to the point where the VIX may start testing its lows again, in the process the SPX may test its top. This time however, the implied volatility may be even lower. If we look, IV actually rallied into the top of 1150 last time. This time I am not so sure. We do have a few economic announcements (initial jobless claims for instance) coming out tomorrow, however, I am trying to find a good reason the market might drop between now, and the employment report next Friday. I will be keeping a close on the SPX volatility as I think there may be a very good chance to enter some sort of long gamma spread. What kind? Read below:
Vinnie points out in the comments of my previous column that downside put skew has increased dramatically over the last few days. This is not uncommon when the market is rallying after a major drop. Traders are still skittish about a return to selling. Even retail traders are buying insurance. Thus, traders are selling the premium and being extra cautious by owning downside risk. This can present some excellent opportunities for traders to get long gamma, at a cheap price. Basically, the trader buys some ATM straddles and then sells some sort of ratio of downside puts and calls against the position. This will allow the trader to possibly create a position that is long gamma and flattish theta.
For the more traditional trader, it makes condors a much more desirable trade than normal; it also makes butterflies less desirable. Tomorrow, I will run through a couple of trade scenarios to take advantage of the ‘fat tails’ of the market.
Disclosure: I have a long theta position in SPX