How to play it: Options trades ahead of the Greek elections

How to play it: Options trades ahead of the Greek elections

By Doris Frankel and David K. Randall

NEW YORK | Wed Jun 6, 2012 3:39pm EDT
(Reuters) – Greece may once again determine the direction of global markets.
Money managers and analysts are looking ahead to Greek parliamentary elections on June 17 that could decide whether the country continues austerity measures it agreed to as part of as an international bailout plan, or whether Greece takes a big step toward leaving the 17-member euro zone.
If Greece does exit the euro currency, Europe’s financial system may further weaken and lead to a freezing of global credit markets. Polls show that Greek voters are roughly split between the conservative, pro-bailout New Democracy party and the anti-bailout, leftist SYRIZA party.
Given the close polls, some market participants are turning to various option strategies, from hedging a portfolio to speculation on global stock market volatility. Unlike a stock, options are contracts that give the right to buy or sell the underlying security at a fixed price by a certain date.
“People are so worried that the stock market is going to fall. I’m taking advantage of the panic in the marketplace right now,” said Tyler Vernon, president of Biltmore Capital Advisors in Princeton, New Jersey, a wealth advisory firm with about $500 million in assets. “Any time you are selling volatility you are getting a lot more in premiums than you were a month ago.”
TARGETED PLAYS
The financial sector, exchange-traded funds that track major benchmarks and some stocks with European exposure could move significantly depending on the outcome of the election.
“My thought is that the European crisis is at its root a financial crisis in its banking system,” said Enis Taner, global macro editor at options trading firm RiskReversal.com. He recommends buying equity puts on investment banking stocks as a way to hedge against a negative outcome from the Greek elections. For those expecting a positive outcome, then upside calls on those financial stocks make sense, he said.
“For example, Citigroup and Morgan Stanley are moving the most closely with European banks,” Taner said.
Others are turning to options as a way to protect their long positions in certain stocks. Vernon, of Biltmore Capital, implemented a covered call strategy in early May to hedge his firm’s roughly $100 million stake in shares of United Parcel Service Inc, which has exposure to the global economy.
In that strategy, calls are sold as a way to generate income on a long position. This trade would bring in roughly $2 per share of stock Biltmore owns, he said.
Mike Tosaw, a portfolio manager of Know Your Options, an advisory firm in Chicago, has set up a put trade as a protective play in the PowerShares QQQ Trust, an exchange-traded fund that tracks the 100 largest non-financial stocks in the Nasdaq composite index. “Regardless of the outcome of the Greek elections, we feel very comfortable due to the fact that we are hedged,” Tosaw said.
He holds a QQQ $64 September strike put, which is in-the-money or below the current value of the fund and plans to keep that put for now as extra insurance for a long position in the fund.
MORE COMPLEX TRADES
The outcome of the Greek elections could lead to a sharp rise in volatility, which creates optimal conditions for a straddle strategy on the SPDR S&P 500 fund, said Gareth Feighery, a founder of options education firm marketTamer.com in Philadelphia.
A long straddle trade involves buying a call and a put with the same strike price and expiration date and is a bet on volatility in the share price. In essence, the investor does not care which direction the underlying security goes, just that it moves dramatically enough to make either bet profitable.
For example, the $131 July SPDR S&P 500 straddle could be bought for $7.56. The trade would be building in an expectation of an almost 6-percent move in either direction in the ETF over the next 44 days, Feighery said. If the fund rises or falls by more than 6 percent, the trade will perform well but it will suffer if there isn’t much volatility, he said.
Straddle buyers risk losing premium paid — the cost of buying the options — if the fund closes at the strike price at expiration.
Jared Woodard, a principal of options research firm condoroptions.com in New York, said that investors can gain some short term exposure by selling a time spread. This is another kind of volatility bet, using short-term or weekly options on the S&P 500 index.
For example, buying the SPX 1300 puts expiring June 22 and selling the SPX 1300 puts expiring July 6 recently could be done at a price for $7.70.
If there is a bad outcome in Greece and volatility spikes, the weekly put expiring June 22 can be expected to gain in value more quickly than the put with a later expiration date, he said.
Conversely, if a pro-bailout government is formed, he expects volatility to decline, causing a loss to the trade. Woodard suggests that this trade be put on closer to the election date, since other events could influence the markets in the interim.
Investors could also consider a volatility hedge, said Credit Suisse equity derivative strategists Mandy Xu and Dmitry Novikov in a report on Tuesday.
They like buying a June 35 call option on the CBOE Volatility Index, which would be fully financed by the sale of the June $124 put on the SPY fund. Buying a call on the VIX is in anticipation of greater volatility and typically another way to hedge against a pullback in the market.
The June $124 SPY put expires on June 15, two days before the election – before volatility would be expected to rise. But the VIX calls which expire on June 20 would take into account any spike in volatility following the event, they said.
(Reporting By David Randall; Editing by Walden Siew)