As we head into the fiscal cliff and a potential European solution/crisis one thing strikes me, risk is not being priced into financial assets. ?Yes, the VIX is somewhat low today, trading at 15% or so. ?The VIX futures, though and the VXV are both pricing in a little more volatility after the December cycle. ?We are not seeing the same thing priced into XLF and/or any of the major financial companies. ?Take a look at the price and IV chart for XLF. ?The Red is the 30 day vol; the yellow is the 60 day vol.
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Notice that both are sitting at 2 year lows, and the spread between 30 and 60 is essentially nil. ?Within that sector there are areas that are incredibly cheap, namely payment processors and some of the banks. ?Does this make sense?
Well, looking back to 2006 and 2007, bank vols were typically in the low teens and this was about the IV that we would see out of XLF. ?I think there is a real chance that we could be at a near term low for XLF vol as those stocks have some real near term increase in volatility, but, in the long run I think this is the vol we should get used to in XLF. ?In fact, despite the risk, I think there is a real advantage to short XLF vol and long vol of some of the components. ?I would also be looking to find XLF related assets that maybe aren?t in the index.
The Trade:
The Payment processors are killing it this year. ?This leads me to my backdoor payment processor play, EBAY. ? EBAY vol is, in relative terms as low as V or MA, while the stock has plenty of room to run higher. ?I would be looking to go long EBAY calls, and potentially short an iron fly in XLF. ?I would choose to push any portfolio somewhat long vega here.