Getting a head start on volatility
01/08/19

●Cigna (CI) has formed a tight consolidation in recent days

●Option open interest was high yesterday, suggesting potential new positions

●Stock rebounded in late December after hitting a nearly six-month low


 

If you’re looking for market action, sometimes you need to look where there doesn’t seem to be any at all.

Volatility is often referred to as “mean-reverting,” a term that loosely describes a tendency to make a big move but then return to a more moderate (average) level relatively quickly. Think: The big jumps in the Cboe Volatility Index (VIX) that last a few days before reversing—like the one to a 10-month on December 24, which was followed by a nearly 50% correction over the next seven trading days.

It’s another way of saying that a market that has exhibited lower-than-normal volatility has the potential to make a high-volatility move, while a market that has just made a high-volatility move may be quieter than usual for a while. Which, in turn, is another way of saying that a market that has gone nowhere recently may be poised to go somewhere, and vice versa.

OK, aside from the standard disclaimers, let’s just point out that any market can go nowhere for a lot longer than many people expect. That said, looking for tight price action and/or low options implied volatility can sometimes tip you off to potential price moves.

Cigna (CI), 10/30/18–1/7/19. Cigna (CI) price chart. Contracting price action.

Source: Power E*TRADE


Health insurer Cigna (CI) certainly hasn’t done much in the first days of 2019. The chart above shows that after selling off with the rest of the market in December, the stock bounced at the end of the month, but spent the past several days in a progressively narrow consolidation.

Now, that doesn’t necessarily mean CI is going to make an explosive move today or tomorrow (or the next day…), but options activity yesterday suggested some traders may be expecting it to do something before too long. A LiveAction scan showed that open interest in CI options was running more than three times its average level in early trading yesterday—meaning, traders were putting on more new CI options positions than they were closing.

LiveAction scan: Unusual option open interest. Cigna (CI) options open interest. High CI open interest.

Source: Power E*TRADE


Long story short, some traders and analysts may think that increasing options open interest + stock consolidation = higher odds of CI revving up its volatility again.

Of course, the question is, which direction will the stock take? Some options traders may not care, possibly preferring to buy both calls and puts to take advantage of an up move or down move (long “straddle” or “strangle” positions). Even many stock traders may choose to play the breakout of the current consolidation—in either direction—on a short-term basis, and take quick profits.

Other traders may look at CI’s sharp December sell-off and see a stock with the potential for more upside, especially now that the company has concluded its $67 billion merger with ExpressScripts.1

Finally, many options traders will note that Cigna is currently scheduled to release earnings on February 1—a date that may change, so check back here, or in the E*TRADE Market Calendar (logon required). Because earnings announcements are often accompanied by big volatility surges—and volatility surges typically increase the value of options—traders considering long options positions would probably want to choose expirations that occur after CI’s earnings date.

Even the best trade idea won’t do you much good if you don’t execute it properly.

Market Mover Update: Dunkin’ Brands (DNKN) added to its recent upturn (see “Sweet spot?”), rallying another 4%-plus yesterday.

Today’s numbers (all times ET): NFIB Small Business Optimism Index (6 a.m.), International Trade (8:30 a.m.), JOLTS (10 a.m.), Consumer Credit (3 p.m.).

Today’s earnings include: SMART Global (SGH).

 

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1 Zacks Equity Research. Cigna Poised for Growth in 2019 on Express Scripts Buyout. 12/28/18.