XLB (Materials) - Three Large Option Blocks

Discussion in 'Options' started by livevol_ophir, Jul 2, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    XLB is trading 28.03 with IV30&#8482 up 2.3%.

    <img src="http://1.bp.blogspot.com/_hMry1m7UF10/TC4temUOe1I/AAAAAAAADVw/iqrdTBiMDzg/s1600/xlb_summary.gif">

    This ETF primarily consists of companies involved in such industries as chemicals, construction materials, containers and packaging, metals and mining, and paper and forest products.

    The ETF has traded over 69,000 options on total daily average option volume of just 18,735. The five lines in play are the Sep 24 puts (sales), Sep 28 puts (purchases), Sep 34 calls (purchases), Aug 28 puts (purchases) and Jul 32 puts (sales). The Stats Tab and Day's biggest trades snapshots are included (<a href="http://livevol.blogspot.com/2010/07/xlb.html">in the article</a>).

    The Options Tab (<a href="http://livevol.blogspot.com/2010/07/xlb.html">in the article</a>) illustrates that the Aug 28, Sep 24, Sep 28 and Sep 34 options are opening (compare OI to trade size). From what I can tell, the Jul 32 puts are short interest and the trades today were also sales. I've indicated with "+" or "-" next to the lines to show purchases (+) or sales (-).

    I see three distinct trades here:
    1) 10,000 Sep 24/34 risk reversal (sell puts/buy calls).
    The trade was done for a $0.64 credit so it make money as long as XLB stays above $23.36 on Sep expo. It starts to make huge money when the ETF rises above $34.

    2) July 32 / Sep 28 put spread (sell July/buy Sep) 15,000/18,000 times
    This is done for a credit and is bullish as it sold the deep ITM puts.

    3) Buy 10,000 Aug 28 puts for ~$1.51

    The first two are long delta, the second is short. All three show some conviction. The ETF averages 13 million shares a day and only 7.5 (ish) million have traded today, so it's hard to tell if these went up with stock throughout the day.

    The Skew Tab snap (<a href="http://livevol.blogspot.com/2010/07/xlb.html">in the article</a>) illustrates the vols by strike by month on the lines that traded (highlighted).

    It's interesting to see the trades occurring all over the skew. That's why the skew has remained in good form, there is no reason for kinks to develop.

    Finally, the Charts Tab (6 months) is below (<a href="http://livevol.blogspot.com/2010/07/xlb.html">in the article</a>). The top portion is the stock price, the bottom is the vol (IV30&#8482 - red vs HV20&#8482 - blue). The yellow shaded area at the very bottom is the IV30&#8482 vs. the HV20&#8482 vol difference.

    We can see the ETF has dropped hard recently (like the rest of the market). Vol has spiked past the realized in lock step with the recent drop. The housing (and commercial) market news has been bad recently and this ETF is sensitive to that.

    Of all the trades, I like the risk reversal the best simply b/c it's done for a credit with a wide range of profitability; it allows for both a continued drop and a sharp recovery.

    This is trade analysis, not a recommendation.

    Details, trades, prices, vols, skews charts here:
  2. msecrist


    This trade looks like a pretty decent setup. Nice find. My bias tends to look for the bounce, which is often like trying to catch the falling knife. However, it hasn't always worked well for me. This trade looks to provide some margin of error.

    You've introduced me to another premium selling strategy. I'm curious though how you manage this trade. Since it's a variation of a naked put, if it went wrong, it could go very wrong. For me, I'd consider putting a stop order in on a cost to close or on an absolute price on XLB.

    Just wondering...

    Nice blog site by the way.

  3. livevol_ophir

    livevol_ophir ET Sponsor

    Hi Mark,

    These trades at this size are done by institutional prop traders (or hedge funds). In that sense, the downside "disaster" risk is easily covered by the firm's margin.

    In the "real world," getting super naked short anything is very risky. For that matter, super long premium is risky as well - though the downside is at least capped. If one were to replicate this, a cheap downise put could be a good move - that put could be funded by a higher strike call sale against the long calls. The trades could be premium neutral but limit the downside while at the same time limiting the upside... for example...

    On a side note, stops become market orders - which is generally not a good idea. Stop Limit is probably a better route.
  4. msecrist


    I agree stops can be dangerous, especially with gap downs on market open or other unusual events. I do use them though it's usually not my ultimate solution. I prefer defined risk trades though as it makes it much easier to size my positions consistently.

    I'm thinking the answer might be to buy insurance by purchasing a further OTM put. This at least caps the risk to the down side. Of course, it means giving up some of my initial credit.