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Morning Update

This morning US equity futures are modestly higher after a sharp sell off yesterday on better than expected earnings from Visa and Facebook and a good PMI in China. Later today new home sales will be released and there will be a Fed announcement. Typically the market is quiet leading into a Fed announcement with sharp moves coming after. No policy changes are expected to be announced today.

Yesterday’s sell off in equities sent many scrambling to buy downside portfolio protection. There was one big trade however, that was doing the opposite. With the VIX at 18.95 one trader sold 32,000 VIX Nov. 19 calls for $1.95. This is a bet that the VIX stays below 20.90 and implies that the S&P 500 has at most only a few more percent to fall before bouncing. Historically the VIX has moved up 4% for every 1% move down in the S&P 500. By that logic, this trade will be profitable if SPY remains above 135.70 through November expiration.

Although the call sold in this trade is 16% out of the money, it is still a very risky sale. A short call has unlimited upside risk, and it is not uncommon for the VIX to make sharp moves upward. Therefore I prefer to keep my risk fixed and defined by buying a further out of the money call when making these types of trades.

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