Project Leiden (update 3)
06 May 2020It’s been an interesting year in the stock markets, to say the least. Leaving the comedy aside (fundamentals don’t matter, printer goes brrrrrr), the basic change has been in the volatility landscape: from a very sedate VIX <15 until mid-February, to >30 for the foreseeable future. A lot of market actors are spooked, but the Fed will likely continue to intervene massively, so it’s reasonable to expect IV higher than actual volatility in the coming months.
In brief: time to sell premium.
Example: MU butterflies. MU is a solid company, not in danger of going bankrupt any time soon, with good volume, trading between 30 and 60 for the past 3 years. During March it hit 36, and it’s relatively unlikely it will drop to that level quickly again (within 1-2 weeks).
Long butterflies a week out, and the potential premium gain is pretty close to the capital at risk, with a relatively wide profit spread. Right now things look good if it stays between $43.28 - $48.72 (if centered at $46).
Of course, the market could crash at any moment, so hedge with a $46-$43 debit put spread 2-3 months out. Suddenly you’re in the green if the stock stays anywhere under $48.72 for the next week.
If it moves higher, sell at your preferred stop loss, try again a week later. (It’s very unlikely MU will shoot up and stay up in this environment.) If it moves lower, use the hedge and wait until it bounces back up to enter new butterflies.
MU could run up, of course, so the portfolio should be diversified between many such stocks. Then the only way to lose would be if the entire stock market keeps breaking all-time highs over the next 3 months.
Given the recent actions of the Fed, possible! But I’d bet against it. I’ll be long butterflies for the foreseeable future, hedged mostly to the down side.