S&P Option Strategies: Trump & Brexit vs Hillary & Butterflies

November 8, 2016 8:16AM CST

In yesterday morning's Technical Blog we extolled the micro bullish virtues of the market's failure to sustain last week's plunge below a very minor corrective high at 2107 from 02-Nov and identified 01-Nov's 2130 next larger-degree corrective high as the next pertinent upside threshold the market needed to recoup to tilt the directional scales even more to a broader bullish outcome.  By yesterday afternoon the market eked out further gains above 2130 and reinforced the odds that Fri's 2078 low defined the end or lower boundary of a major BULL MARKET correction from 23-Aug's 2192 high.

As a result of yesterday's performance and the market's apparent bet that a Clinton victory would result in a less uncertain world than a Trump victory, we can state with greater confidence that Fri's 2078 low now serves as our new short-term parameter from which the risk of non-bearish decisions like short-covers and cautious bullish punts may now be objectively based and managed.  Still, further strength above our long-term risk parameter defined by 25-Oct's 2150 corrective high remains required to really render the entire Aug-Nov sell-off attempt the 3-wave and thus corrective affair we believe it to be.

This said, let's not forget the bullish confidence many British voters must have felt heading home on 23-Jun when sterling was on a strong 6-day run to new SIX MONTH HIGHS before everything went absolutely blotto the very next day after the Brexit vote was tallied.  In one of our option strategies below we will address a cautious but favorable risk/reward way to prepare for such a shocker.

Emini Daily

In recent updates we have identified the 2084-to-2082-area as one of potential technical significance.  These levels represent the 50% retrace of Jun-Aug's 1981 - 2192 rally and the 1.000 progression of Aug-Sep's initial 2192 - 2100 decline from 22-Sep's 2173 high shown in the daily log scale chart above.  As always, we warned against RELYING on these merely derived levels as support until and unless the market stemmed the broader developing downtrend with a confirmed bullish divergence in momentum.  While a recovery above 25-Oct's 2150 larger-degree corrective high and key risk parameter would be best, yesterday's recovery above our short-term risk level at 2130 suffices in defining Fri's 2078 low as "enough" of a low that we can objectively rely on this level as one of developing importance and a short-term risk parameter from which bullish decisions can now be objectively based and managed.

Only a glance at the weekly log chart below shows that the general 2100-area remains arguably intact as a MAJOR area of former resistance that, since broken in mid-Jul, now serves as new major support.

To this point the decline from Aug's 2192 high has unfolded into a 3-wave affair as labeled in the daily chart above.  Left unaltered by resumed weakness below 2078, this 3-wave setback is considered a corrective/consolidative affair consistent with our long-term bullish count to eventual new highs above 2192.  Further gains above 2150 will reinforce this count while a relapse below 2078 will negate it and expose further and possibly steep losses.

Emini Weekly

Finally, on a very, very long-term basis shown in the monthly log scale chart below, the trend remains clearly up and should be expected to continue and perhaps even accelerate until mitigated by commensurately larger-degree weakness below at least Jun's 1981 corrective low and preferably Feb's 1802 low.  Against this looooong-term bullish backdrop it's not hard to envision the past 2-1/2-months' piddly setback as a mere correction.

These issues considered, shorter-term traders have been advised to move from a cautious bearish policy to a neutral/sideline one.  The quickness with which the market rebounded yesterday leaves only Fri's 2078 low as a risk parameter to bullish exposure, and this is kind of rich for shorter-term traders, so we advised waiting for an interim corrective setback for a preferred risk/reward buying opportunity.  And while the market has yet to recoup that 2150 threshold, longer-term players are advised to take a similar tack.  Additionally, both bearish and quasi-bullish option strategies below may be considered.

Emini Monthly

FOR BULLS:  NOV WEEK-3 2110/2140/2170 CALL BUTTERFLY

While it has become apparent that the market views a Clinton victory as less unfavorable than a Trump victory, the market has thus far only returned to the middle-half of the suspected consolidation range it has defined over the past 2-1/2-months.  Yes, ultimately we believe this price action is consolidative ahead of the eventual resumption of the secular advance that preceded it.  But over the course of the next 10 days until the Nov Week-3 options expire and after the dust of a Clinton victory settles and recent high implied volatility erodes, the market could easily end up still stick in the middle half of the 2192 - 2078-range.

A cautious, fixed risk way to approach this range environment is via a call butterfly strategy.  This strategy involves buying 1-unit of the Nov Week-3 2110 Calls for around 43-pts, selling 2-units of the Nov week-3 2140 Calls around 23-pts and buying 1-unit of the Nov Week-3 2170 Calls around 7-pts for a net cost of 4-pts ($200 for a 1-lot play).  This strategy provides:

  • maximum risk/cost of 4-pts on any decline below 2110 or rally above 2170
  • breakeven points of 2114 and 2166 at expiration 10 days from now on 18-Nov (meaning profitability with a contract settlement anywhere between this range)
  • maximum profit potential of 26-pts ($1,300) if the Dec contract settles at 2140 at expiration on Fri 18-Nov.

In sum, this call butterfly is basically a bet that the market will close next Fri somewhere between 2114 and 2166 and be higher (with a Clinton victory) than where the market's trading today (2125), keeping in mind that the market remains within a 2192 - 2078-range over the past 2-1/2-months.

Chart

FOR BEARS (and/or those looking to hedge against a Brexit-like Trump shocker) - NOV WEEK-2 2070 / NOV WEEK-3 2040 PUT DIAGONAL

Perhaps not surprisingly, implied volatility in the Nov week-2 options that expire this Fri is through the roof, roughly 50% higher than week-3 options and twice that of the Dec options.  To help mitigate the risk and cost of buying a week-1 option, traders can sell a week-2 option against it.  Specifically, and keeping in mind that the pivotal 2078 low was made just two trading sessions ago, we advise this put diagonal strategy that involves buying 1-unit of the Nov Week-2 2070 Puts around 13-pts and selling 1-unit of the Nov Week-3 2040 Puts around the same 13-pts for a net cost of "even".

This strategy provides:

  • a current net delta of -0.05
  • 2:1 gamma ratio
  • negligible risk if the market rallies sharply
  • profit potential of up to 30-pts if the market collapses below 2070.

While a Clinton victory doesn't guaranty higher prices, it likely reduces the odds of a larger0degree correction or reversal lower.  If Clinton wins, that gasping sound one hears will be implied volatility and premium rushing out of the Nov Week-2 2070 puts that will likely erode to zero quickly.  And while the short Nov Week-3 2040 puts will absolutely go down as well, the fact they'll retain seven days' more time premium will cut their loss to something less than that of the Week-2 2070 puts.  Also, a naked short position will eventually result in the Nov Week-3 2040 puts, an unenviable position that we would not advise if the market doesn't prove strength above that 2150 threshold in the contract needed to really reinforce a bullish count.

If Trump wins and the contract collapses below Fri's 2078 low, we'll advise managing this position like an aggressive short futures position.  If, alternatively, Clinton wins, this strategy should lose a small amount and should be neutralized altogether by the end of this week.

Please contact your RJO representative for updated bid/offer quotes on these strategies.

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