Even before I look at the company or the technicals there must be one thing present:

Volume.

Specifically options trading volume. If the total volume in a stock’s option chain is under 3,000, it’s pretty much off my list.

This significantly shortens the time I need to use for research.

But, the list of liquid options seems to be shrinking, in more ways than one.

The Great Volume Concentration

Bear in mind that all I have is anecdotal data to back this up and haven’t done any empirical studies.

But it seems that the total options volume distribution continues to funnel into the same names.

So it’s $AAPL, $BAC, $C, $INTC, $MS and so on.

This makes sense for a few reasons.

First, that’s where the majority of trading volume is taking place. Even if it is the robots trading against each other, there is a need to hedge equity positions. If a stock doesn’t have a lot of participants, then the demand for options is much lower.

Furthermore, the high-correlation market that we saw back in 2011 seems to have everyone still focused on leveraged etfs rather than individual companies.

That means a good portion of “fun” stocks from a few years ago aren’t really playable in any size.

For now all of these points are “known knowns.”

But it goes a step further.

Time Concentration

The other liquidity issue has been a direct result of weekly options being introduced into the market.

And this has much larger consequences.

thumbs up if you get the reference

Think about this: what is the purpose of the options market? Hopefully all my OptionFu students reading this are shouting out the right answer.

The options market exists as a risk exchange, where risk is transferred between two parties in exchange for a premium. The pricing of that premium is how you make money in the options market.

So there have to be two parties involved, generally a hedger and a speculator.

I believe that weekly options have created a schism in the market between hedgers and speculators.

Weekly options have a duration at most of 9 days.

And if you’re a fund or larger investor looking to hedge a position, odds are you want protection longer than 9 days.

The problem here is that the liquidity beyond the weekly and front month options have grown anemic. And the majority of weekly options are simply speculator vs. speculator.

So What?

This isn’t necessarily a complaing, more an observation about how the market has changed. Certain option trading strategies limited only to expiration week are now playable every week. Weekly options give you the ability to speculate with very limited amounts of risk capital.

But the inability for large players to hedge without significant liquidity risk may keep them away from the market, or at least move them towards market-based hedging rather than covering up a single position.

This has huge implications, not only to the potential volatility of the market, but also to options related data like put/call ratios and the like.

And while I may have been a touch early, the thesis is starting to pan out.

When we trade options, we look at the implied volatility of the option to figure out the perception of risk by the market.

And this “risk” will be different across asset classes, even though they can be highly correlated.

The Big Macro Thesis

So far, this summer is starting to pan out just like the past few years. Greece is ugly, risk is blowing out in sovereign swaps, and that’s helping to bring weakness into equities as investors go towards “safe” assets, like treasuries.

Shopping for Risk

Because of this heightened risk, the VIX has seen a strong rise after getting very low in march. The closing spot VIX from Tuesday was 19.05, and the VX futures are working off their contango from the past 6 months. However, relative to realized volatility the premiums are awfully rich.

But if this volatility is driven by euro-related news, how are $FXE options faring? We can look at EVZ, which is the VIX for the euro:

Quite honestly it hasn’t budged, and a euro crisis would most likely have $FXE options more responsive than $SPY options.

The Trade

It’s a very simple trade:

Buy volatility in the Euro

Sell volatility in equities

This can be accomplished a few ways. For equities, Jul iron condors in $RUT make pretty good sense here.

For the euro, a simple straddle buy would work. For a more advanced play, a time spread sale in /6E options would benefit from a relative rise in vol on the near term options, which would happen if we get a fast move.

It may seem like this trade will at best be at breakeven.

But remember, this is also a vol play. If the Euro starts getting loose to the downside, both options on your straddle will run higher.

And as it stands right now, the premiums are running way too hot on the RUT relative to the volatility.

What do you think? Good trade or full of it? Let me know in the comments.

Nevertheless, there are tops forming in the $SPY $IWM and $DIA.

You will see what kind of tops these are as well as potential downside targets.

Fuckarounditis most commonly manifests itself as an intense preoccupation with forex robots, macro newsletters, permabears,  magical technical analysis, permabulls and poor risk management. Fear of taking losses and being wrong is another distinguishing trait. Mental discipline is either completely lacking or misapplied (towards questionable or unproductive trading practices).

Environment and social networks are crucial factors for triggering the disease. It has been proposed that the roots of the disease stems from misinformation and counterproductive training advice found in popular media and information hubs on the Internet.

Human nature and the so-called “laziness”, “magic bullet” and “complacency” genes plays a permissive role for allowing the disease to take hold.

The disease spreads rapidly, as carriers of the disease communicate with other individuals at conferences, investment clubs, Internet discussion forums and other arenas of interaction and information exchange in real life or otherwise.

The onset of symptoms typically occurs in young adulthood and may go undiagnosed for a lifetime. Diagnosis is set by a professional and based on observed behaviors and account gains.

Adapted from Martin’s Post