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Tuesday, March 31st 2020

Navigating This Market With Options Data: The 2008 Model

There are parallels of the 2008 financial crisis to the corona virus crash. The implied volatility rose to 75% in both cases and fell to 45% thereafter. What will happen next?

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Summary

This article draws parallels between the current market situation and the 2008 financial crisis, noting that implied volatility rose to 75% in both cases before falling to 45%. The author suggests using a put spread collar to protect against further market downturns, but acknowledges that this strategy limits potential upside.

There are not many similar market situations to the one that we find ourselves in today.  With such a dramatic fall in stock prices and rise in implied volatility, investors puzzle over how to act.

Options information can present some historical parallels that can help navigate this market. The 2008 Global Financial Crisis has some similarities: After the SPY IV 30 day hit 75% the market rallied and did not turn until the IV fell to 45%. In the current crash, SPY IV again hit 75% before rallying and today the IV is back to 45%. The question is: Will the 2008 history repeat.

If you think we are in for another down leg to this market. You can protect your long stock, index or ETF with a put spread collar. This is for an example only and not investment advice and meant to draw your attention to the put spread collar strategy and show an example.

In the market currently, with the SPY price around $260, an example September put spread collar:

  • selling a call 10% out of the money, the $285 strike
  • buying a put 10% below the stock price, the $235 strike put
  • selling the $180 strike put

This package can be done for even money, no outlay of capital. Here is the payoff picture at September 18th, 2020:

Interpreting this chart, with the market down 30% you lose $300,000 with long SPY on a $1 million holding. In the put spread collar you lose $85,000. What you give up for this strategy is limiting your upside: with long SPY you make $300,000 if the price were to hit $340 and only $100,000 with a put spread collar. 

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The opinions and ideas presented herein are for informational and educational purposes only and should not be construed to represent trading or investment advice tailored to your investment objectives. You should not rely solely on any content herein and we strongly encourage you to discuss any trades or investments with your broker or investment adviser, prior to execution. None of the information contained herein constitutes a recommendation that any particular security, portfolio, transaction, or investment strategy is suitable for any specific person. Option trading and investing involves risk and is not suitable for all investors.

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The opinions and ideas presented herein are for informational and educational purposes only and should not be construed to represent trading or investment advice tailored to your investment objectives. You should not rely solely on any content herein and we strongly encourage you to discuss any trades or investments with your broker or investment adviser, prior to execution. None of the information contained herein constitutes a recommendation that any particular security, portfolio, transaction, or investment strategy is suitable for any specific person. Option trading and investing involves risk and is not suitable for all investors. For more information please see our disclaimer.
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