At the end of the day, trading — and to a large extent investing — is about finding inefficiencies. When it comes to the typical buy-and-hold approach, the idea is that quality but overlooked enterprises will eventually rise to their true value. It’s much the same principle with options, where the relatively thinner volume may help facilitate favorable pricing inefficiencies.
One possible example of such an inefficiency is banking giant Citigroup (C). Prior to the end of last week, concerns existed about the stability of the U.S. and global economy. Investors nervously held their breath as financial behemoth JPMorgan Chase (JPM) got ready to disclose its third-quarter earnings report. Not surprisingly, implied volatility (IV) punched higher as the day approached.
Well, Friday came and went and the only cries of disappointment — aside from San Diego Padres fans — came from JPM bears. As Barchart content partner Zacks Investment Research noted, the big bank’s performance metrics reassured Wall Street. Primarily, JPM beat analysts’ targets for earnings per share and revenue. Further, management provided positive guidance for the current quarter.
Subsequently, JPM’s IV rating shrank noticeably — a phenomenon known as volatility crush. As of Friday’s close, the average IV of the bank’s options chain sits at 24.48%, below its historical volatility (HV) of 26.95%. Prior to the Q3 earnings report, these metrics were flipped, meaning that the market incentivized credit-based strategies.
Predictably, the market is no longer incentivizing a credit trade on JPM — that hole is closed. However, through the use of Barchart Premier, we can find another compelling opportunity in C stock.
Laying the Foundation for a C Stock Credit Spread
Vertical credit spreads — where we buy and sell options of the same expiration date — can help us generate income from the sold option and cap risk with the bought option. Evidence indicates that most retail traders who participate in options trading simply buy calls or puts. There’s so much more to this segment of the derivatives market and Barchart Premier is your ticket to illumination.
As stated earlier, the IV for JPMorgan stock options was steadily rising ahead of the underlying firm’s earnings disclosure. Without knowledge of what was in that report, investors could do nothing but speculate. Since the market anticipated a wide range of pricing possibilities, IV expanded. In other words, the premium on these options spiked higher, making them lucrative to sell.
Once the data was disclosed, there was really nothing for the market to immediately look forward to. IV dropped like clockwork and there is now less motivation to sell JPM options. However, the same cannot be said about C stock options since Citigroup is scheduled to disclose its Q3 results on Oct. 15.
When the closing bell rang out on Friday, the average IV of its options chain stood at 35.31%. This is noticeably above its HV of 27.59%. Also, its IV rank has been swinging sharply higher since the beginning of this month. Even though the finance sector’s leader delivered better-than-expected results, the Street is still nervous about downwind names like Citigroup.
That may present a massive — albeit short-lived — opportunity in C stock options. By selling a credit spread, speculators can extract quick yield while controlling their downside exposure. But which spread should you pick? That’s where Barchart Premier helps save considerable time and frustration.
Not Just Picking but Picking the Best
Before we dive into the details, it’s important to recognize that not all option chains are perfectly efficient; that is, an increase in the measure of risk does not necessarily result in a proportionate rise in the magnitude of reward.
Imagine if you will a track and field event at the Olympics. When runners compete in the 100-meter dash, it doesn’t matter (outside of personal preference) which lane they pick. Each lane extends to an identical distance. However, if certain lanes were shorter than others, runners would naturally compete for these favorable lanes.
And that’s really what we’re saying about options. Some transactions simply offer better bang for the buck.
For example, suppose that you’re relatively conservative about C stock. If so, you’ll probably want to consider the 64/63 bull put spread: specifically, you would sell the $64 put and simultaneously buy the $63 put. This trade gives you the benefit of a 23.46% yield while providing a profit probability of 72.5%.
Sure, you can go for a more rewarding trade. But the next highest-yielding transaction would be the 65/61 put spread for a 24.22% yield. You can go for that but the profit probability dips conspicuously to 66.1%. Further, the gap between the closing price and the breakeven price for these two trades narrows from 2.94% to 2.05%.
Also, please note that the next step down in terms of profit probability from the 64/63 put spread would be the 65/59 spread at 68.9%. However, the yield for this trade would dip to 16.73%. That’s unfavorably inefficient since the more risk you take, the more reward you want.
Therefore, from the context of conservative income generation, you’d arguably be hard pressed to find something better than the 64/63 bull put spread.
Extending the Offer
This is where it gets interesting. C stock is but one idea among thousands. Every business day, a countless number of trades occur in the options market. Most of these trades are functionally efficient: for an increase of risk, there is a proportionate increase in reward.
However, as we demonstrated above, some transactions are inefficient. Without Barchart Premier, it’s too easy to stumble into a bad trade simply because the price appears low, or the potential payout seems high. However, with this paid membership, you can easily and objectively identify the inefficiencies that work in your favor.
The best part? It’s likely impossible to find a perfectly rational and efficient derivatives chain. That means there are “mini-arbitrage” or arbitrage-like ideas materializing every day. Barchart Premier gives you the tools to extract these opportunities, all for what amounts to a streaming service subscription fee.
So, seize the chance to capitalize on these market gaps before they close!
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
