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Weekly Options Take Charge

 
Friday, March 10th, 2017 | Vance Harwood
 

The volume of CBOE’s Weeklyssm options has grown rapidly since they expanded their listings into equities and Exchange Traded Products in June 2010.  Now weekly options comprise almost 30% of the CBOE’s average daily option volume.  The list of available weekly options is available on the CBOE website.

http://www.cboe.com/micro/weeklys/introduction.aspx

http://www.cboe.com/micro/weeklys/introduction.aspx

Among other things option traders take advantage of the Weeklys to position themselves for earnings releases,  harvest rapid premium decay near expiration, and place low cost directional plays.

Three recent press releases suggest that the Options Clearing Corporation (OCC) and the CBOE are moving to the next phase—making up to 5 weeks of options available on popular securities and moving existing options to look more like the Weeklys.  The specific moves are:

  1. Five weeks of Weekly options for many securities (press release)
    •  Initially Weekly options were only made available 9 days before their expiration.  If you needed a later expiration date your only choices were monthly options with their 3rd Saturday of the month expiration, or in some cases quarterlies.    In 2013 the CBOE started making SPX options available with weekly expirations 5 weeks in advance.   Evidently encouraged, they rolled out additional weekly expirations for additional  indexes and stocks (e.g., SPY & AAPL).    Overall I think the advantages of a more regular set of dates will outweigh the  problems with spreading option volume across more option classes.
  2. Friday afternoon expiration for most monthly options
    • The OCC announced a plan to change the expiration date for monthly options—to align with the Weeklys.  Instead of expiring on Saturday, they would expire at the end of trading Friday.   The Saturday expiration always seemed awkward to me, causing confusion on theta calculations and exposing investors to weekend news events.  I suspect it’s a throwback to days when paper actually had to be shuffled to close things out.  This change, planned for February 2015, would render the 3rd Friday of the month options indestinguishable from Weeklys.
  3. Rationalizing ticker symbols with SPX options (press release)
    • There are  three different tickers for SPX options,  SPX, SPXW, and SPXPM. Unlike other options there are weekly options (PM settled) on the same week that the monthly (AM settled) expire.

In general the move to weekly options has been gradual and non-invasive.   One of the side benefits of the rise of the SPX weeklys is that now there are always options series that closely bracket the 30 day volatility window of the VIX calculation.  Using the monthly SPX options there were sometimes longish extrapolations required with suspect accuracy. In October 2014 the CBOE switched the VIX calculation methodology to take advantage of the SPX weeklys availability.   Ultimately this new VIX calculation was needed to support VIX Weekly futures and VIX Weekly options.

Possible XIV termination events

 
Sunday, October 15th, 2017 | Vance Harwood
 

In the prospectuses for  XIV, there are some disconcerting discussions about termination events. For XIV the termination event is triggered if the daily percentage drop exceeds 80%. I did some digging into these events to try and figure out how likely they are to occur.  If you’d like to read a more general discussion about this ETN you can read this post.

First of all  XIV provisions for termination/acceleration relate to VIX futures not the CBOE’s VIX index. The VIX relates to the instantaneous implied volatility of the S&P 500—which is a different thing. Volatility futures have contracts with different expiration dates. Typically the further out their expiration dates (e.g., 6 months from now), the slower they react to the day-to-day moves of the market. XIV is based on the two futures contracts that are closest to expiration, the administrators for these funds adjust their positions in these contracts daily to achieve an effective average time till expiration of 30 days.

VXX does the same thing, except it is trying to be long volatility, not short/daily inverse % of volatility. When trying to understand XIV you can view them as being a short position in VXX , or tracking the opposite daily percentage move of VXX (XIV).

VXX is not as volatile as the VIX index. On a day with sharp market moves VXX will typically move about half the percentage move of what VIX does. VXX can still make big moves however—one day during the May 2010 Flash Crash, it jumped almost 25%—the VIX on that day jumped 46%.

Now we can talk about termination / acceleration. I think it is reasonable to assume that the goals of the ETN providers in including these measures are to:

  • Prevent the ETN value from going negative (they specify in these prospectuses that the value will be greater than or equal to zero)
  • Protect the provider from undue market risk in hedging these products during volatile times

With XIV termination (or “acceleration” in marketing speak) relates to daily percentage moves. If VXX jumped more than 100% in a day, then if VelocityShares didn’t terminate XIV its notational value could go below zero.   They avoid this particular unhappy situation by terminating the fund if the daily move of VXX is 80% or more—although losing 80% in one day would still be plenty traumatic.

Just to be clear, this fund isn’t tied directly to VXX, but rather the underlying futures contracts, but I believe VXX is a good proxy for the situation.

The termination risk for XIV appears to be limited to market crashes worse than the Flash crash. Two examples that come to mind are the 2009 crash and the October 1987 crash. VXX didn’t exist for either of these. I have analyzed VIX data (or simulated data) since 1992—there were 20 days with VIX jumping over 30% (previous day close to intraday high) during that period. The highest percentage jump over that period was 70.5% on February 27, 2007. There were three days with VIX jumps over 30% in the 2008/2009 crash, and during the Flash Crash.

If VXX had existed during this time span and held to its typical behavior of 50% of VIX’s move it looks like the XIV termination event would not have occurred, but obviously it would have taken heavy losses on those days.

If you are investing significant amounts of money in these products it looks prudent to at least hold some OTM VIX or VXX  calls. These would provide some insurance against these infrequent, but dramatic events.

Thanks to Steve, who commented on the first version of this post pointing out that the ETN providers were probably not looking out for the investor, but rather for their own hides in incorporating these termination events.

April Condor

 
Monday, January 17th, 2011 | Vance Harwood
 

Put a condor in place on S&P 500 April futures.   The call spread was at S1350 (sell-to-0pen) and S1370 (buy), while the put spread was at S1140 (sell-to-open) and S1100(buy).  The net credit on each set of four options before commissions was 6.15 points.   With S&P 500 futures each point is worth $250, on the futures as well as the options on the futures.

With the S&P 500 at 1290 there is a 4.6% upside margin  before the short call goes in-the-money, and 11.6% downside before the short call goes in-the-money.  The worst case loss would be 33.85 points per contract set.  Currently this position pretty close to delta neutral, and the plan is to close out, or roll this position in 30 to 45 days.

Option spreads, early exercise and other wrinkles

 
Thursday, January 6th, 2011 | Vance Harwood
 

A week ago Monday I created an IEF (iShares Lehman 7-10 Yr Treas Bond) bear spread in my Schwab margin account—with the short calls deep in the money at S90.   Several of the calls were assigned that night when IEF went ex-dividend ($0.248/share).  Since I wasn’t long IEF, this assignment resulted in a short position being created in my account.   I was surprised the calls were assigned since they don’t expire until January 22nd, but not unhappy collecting a small amount of premium early,  being shifted into a position with no more risk (the paired long calls were still in place), and more profit potential if IEF really drops.

On Wednesday I received a call from Schwab regarding the short position.   Evidently they had no IEF shares to loan to create the short position, so I was politely informed that I had two choices:

  • Work with them to try to borrow IEF shares from other brokers (some additional cost involved)
  • Close out the short position by the end of the week (which seemed like a generous amount of time)

I think it’s odd that a big player like Schwab doesn’t have a couple hundred shares of IEF available to short (overall short interest about 4.5%), but previously when I’ve checked, Schwab has always shown IEF in the “Hard to Borrow” category.

Rather than pay extra, I sold-to-open a couple S91 calls at 2.05 to collect a little bit more premium and bought IEF shares to cover the short.

An analogous situation can happen with option spreads in an IRA account if short calls are assigned or expire in the money, however in an IRA you can’t maintain a short position indefinitely, even if there were shares available to borrow—you have to cover the short.

Another brief condor

 
Monday, December 27th, 2010 | Vance Harwood
 

Similar to last week I don’t expect much market action this week.   I put a SPY condor in place with the quarterly options expiring this Friday the 31st.  The puts were at S123 (buy at .19), S124 (sell-to-open at .33), and the calls at S126 (sell-to-open at .43) and S127 (buy at .16) for a net credit 0f 0.41.   Worst case loss is 0.59.   SPY was at around 125.33 at the time.