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Signal du Jour - short vol in BOIL
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Signal du Jour - short vol in BOIL

Is the option market poised for a cooldown?

Jan 16, 2025
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Signal du Jour - short vol in BOIL
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The equity market has had its best days since Trump got elected, and the VIX is back at 16. Let’s see if realized volatility finally drops as we head into MLK weekend.

In the meantime, we’re diving into a trade opportunity in BOIL, the ETF that offers investors exposure to three times the performance of the natural gas market. We successfully sold some calls a couple of weeks ago as the skew tilted heavily toward the call side. Today, however, we’re shifting our focus back to the good old variance risk premium (VRP).

Let’s take a closer look.

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The context

BOIL has had quite the winter so far, surging an impressive 64% in just a month. Colder-than-expected temperatures in Europe, coupled with a sharper-than-anticipated depletion of U.S. natural gas reserves, have driven this remarkable rally. Interestingly, this move closely resembles last year’s trajectory, when BOIL climbed from 120 to 180 (adjusted after the split early November) before experiencing an extraordinary descent of nearly 60% by February. While we’re not suggesting history will repeat itself this year, the seasonality of the commodities market certainly makes this worth watching closely.

That said, situations like this highlight where volatility traders can hold an advantage over directional trading: the key lies in assessing the current level of market risk and comparing it to what the options market implies without pandering if it will go up or down next.

Realized volatility is quite elevated at the moment following the rallye in the asset.

As expected, realized volatility has been climbing over the past few months but has stabilized around 80% throughout December, even as BOIL continued its upward march. While we don’t have a directional view on the asset, we can attempt to forecast realized volatility for the coming weeks.

We expect realized volatility to calm down over the next few weeks.

At this stage, we anticipate realized volatility in BOIL to ease slightly, settling around 70%. While still high (compare it to the relatively calm 16% we’ve been seeing in SPY over the past month—spare a thought for those navigating natural gas markets), this expected decline gives us more confidence as we move into the next phase of analysis.

Let’s now examine how much additional premium is currently baked into the options market.

The data and the trade methodology

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