As we all know, trading volatility is a numbers game. Identify attractive opportunities in relative implied volatility and consistently deploy high probability positions.
While the tastytrade approach emphasizes quantitative analysis, there remains a place for qualitative information, too.
For example, when certain news events start dominating headlines, implied volatility often increases for underlying symbols that have perceived exposure to the topic du jour. Following these developments can be a good way of staying engaged in the market and turning up new ideas.
In recent months, worldwide attention on missile tests in North Korea has intensified. The White House has done little to qualm concerns that the conflict could escalate. Coincidentally (or not?), stocks exposed to the defense sector have also performed extremely well in 2017.
In order to better understand these qualitative observations, the Options Jive team decided to take a look a closer look at quantitative developments in the defense sector.
The chart below illustrates how several of the well-known defense stocks have outperformed the S&P 500 so far in 2017:
As you can see from the above, Boeing has been particularly strong this year, with Raytheon in 2nd. The above graphic shows clearly that the defense stocks are correlated to each other, but how about to the broader market?
In order to better understand how these stocks move relative to the SPY, the Options Jive team ran a 3-month correlation of each name against it. The results of that examination showed that correlations between these names and the SPY is generally low.
The fact that correlations between these stocks and the SPY is fairly low means that attractive opportunities in the sector may allow us to further diversify risk in our portfolios. Because adding similar position structures in highly correlated underlyings is effectively doubling down on the original bet.
In order to further evaluate the defense sector, the hosts of Options Jive walk viewers through research which backtested the historical performance of short strangles in five prominent defense names (LMT, BA, RTN, GD, NOC).
The following parameters were used in the study:
30 delta strangles
LMT, BA, RTN, GD, and NOC
data from 2005 to present
The results of the above study, which are presented in detail on Options Jive, revealed attractive win rates for the period examined - all five around 80% or better. This data, combined with ongoing developments in the defense sector, make it worthwhile to probe the sector further for potential trading opportunities.
At present, a cursory look at the five names included in the study does not show extremely elevated levels of Implied Volatility Rank (IVR). For this reason, it’s likely prudent to monitor events and implied volatility sector in the event something changes, and conditions warrant a possible addition to our portfolio.
If you’ve traded the defense sector in the past, or are considering doing so in the future, we encourage you to leave a comment/question in the space below, or reach out directly at email@example.com.
Thanks for reading!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.