Early in my trading career, someone introduced me to the mighty condor. ‘Twas a fine bird with iron running through her veins and a wingspan that would make LeBron James jealous. Since then I’ve cared for countless condors. I even carved out a beautiful little spot in my portfolio for an aviary. That way I can look after my beloved flock with ease. Most of the time they are well behaved. On a rare occasion, they try to peck my eyes out.
This year my feathered friends have been on their best behavior. No squawking or squabbling, no pecking or peeing (on me, that is). Credit for their behavior lies in large part with market conditions. The Russell 2000 has been locked in a narrow range for many moons.
And that, friends, is starting to concern me. If there’s one thing I’ve learned over the years, it’s that volatility ebbs and flows. Periods of compression are eventually interrupted by expansion. The pent-up energy in a coiled spring will always be released. Stocks in a multi-month slumber eventually awake. And it can be one of the rude variety. To measure just how tight the range has been in the Russell I like to use the Bollinger Band indicator. It’s an adaptive volatility envelope that contracts during sleepy markets while expanding during exciting ones.
The longer the market naps, the tighter the bands squeeze. And the tighter the bands squeeze, the higher the likelihood that a volatility surge will strike. Take a close look at the chart above. Notice the squeeze at the end of the graph, the narrowing of the bands? To quantify just how tight the bands have constricted, I’ve included a BB Width indicator in the lower panel which measures the distance between the upper and lower bands. See how it’s dropped to $5.24? Not only is it the lowest the reading has been over the past few years, but it’s also the lowest it’s been in decades.
And that means it won’t last. We could argue the Russell has already started to awake this week, what with its sharp rally and all. Is our friendly small-cap Index just a bit unsettled because of a bad dream or is he really waking up? Was this week the beginning of a volatility expansion, sure to continue? Am I about to get my eyes pecked out by my June condors? These are the concerns of this condor caretaker.
Now, what am I going to do about it?
Follow my plan, man. Like always. My weapon of choice to combat the occasional unruly bird is to hedge by adding to the winning side. In this case, I would be adding extra bull put spreads to my June Condor.
What are you going to do if upside volatility accelerates?
Financial freedom is a journey
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