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Options Expiry and the Fed Could Cause a Wild Week — Be Ready

by | Dec 13, 2021

This past week brought out an onslaught of media bears overreacting to the omicron variant and inflation numbers that have peaked. I wouldn’t be surprised if we saw more media-driven panic because things could get dicey.

Not only do we have options expiring at Friday’s close, but we get a flurry of economic data that will require our best strategies for trading volatile markets this week.

On Monday, tech retreated from all-time highs and small caps got smoked on a volatile, back-and-forth session amidst subdued media headlines.

And though the S&P 500 essentially finished flat, it was a wild ride — swinging from a small bump in the pre-market session to a total capitulation in the last 30 minutes.

Source: Bloomberg

We get producer inflation data Tuesday…  retail sales, import prices and inventories on Wednesday morning… and the all-important Federal Reserve interest rate decision that afternoon.

Combine any potential surprise there with Friday’s monthly options expiry, and we may start to see a CBOE Volatility Index (VIX) average in the 20s.

For the uninitiated, the VIX — or the “fear index” — represents the amount of volatility in the market. A reading of 20 means we can expect average market moves of1% up or down each day. The higher above 20, the more volatile the market. The lower under 20, the less volatile.

Source: Bloomberg

Friday’s ratio of implied volatility (bets that prices will crash within 30 days) to realized volatility (the actual volatility over the past 30 days) flipped to negative for most sectors. That’s because the post-Thanksgiving selloff raised realized vol (the denominator) and the subsequent 50% pullback in the VIX collapsed the numerator. 

Source: Fortune Research

When that happens — on Friday, we saw it in Energy, Financials, small caps, Communications, Consumer Discretionary and Tech — that’s actually the best time to sell.

Trading Volatile Markets This Week

All those sectors were down Monday, by the way.

Source: Bloomberg

Another way we can view that dynamic is by pulling up the total put/call ratio to see if it’s peaking…

Source: Barchart

I’d say it is!

For us, there are a couple of things we want to do to trade this volatile market.

First, buy the dip on some targeted retail stocks with positive fundamental outlooks for Q4. RH Inc. (NYSE: RH) and PVH Corp. (NYSE: PVH) in particular come to mind.

Secondly, ignore the crypto space for a bit, because volatility and the strength of the U.S. dollar during a selloff could just crush it short term. 

As of Monday, all but eight coins in the entire crypto space have positive one- and three-month returns… just terrible.

That means we’re removing Amplify Transformation Data Sharing ETF (NYSEArca: BLOK) completely after its flip to negative three-month momentum, and we’re keeping Coinbase Global Inc. (Nasdaq: COIN) on a short leash.

We’re also adding the iPath Series B S&P 500 VIX Short-Term Futures ETF (NYSEArca: VXX) in its place so we at least have one option to play some downside ahead of this week’s watchlist update.

But until then, watch out and keep any purchase sizes small… This volatile week could get even wilder.

All the best,

Matt Warder

Fortune Research

WRITTEN BY<br>Matt Warder

Matt Warder

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