Wednesday, June 20th, 2018

Options Trading Volatility

 

The talk these days in options trading seems to be all about volatility. Options trading volatility is nothing new. The prime reference for options trading volatility is the VIX. According to the CBOE web site, “The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility.” One can forgive the CBOE for hyping their volatility measure as “…the world’s premier barometer of investor sentiment…” The VIX is, in fact, a widely used to guide investors and options traders. No matter what kinds of options trading one engages in what has nearly everyone spooked is what some refer to as volatile volatility.

Lacking a clear idea of where the economy and markets are going traders and investors are jumping into the market for fear of being left out of a rally. Then they jump out for fear that the market will plunge again. Amidst all of these fears options traders watch the VIX. VIX numbers above 30 tend to go with subsequent market declines where as lower numbers tend to predict stable markets. Whether trading steel options, buying puts on the financial select sector SPDR, trading gold options, or options trading the BP oil spill, it is the options trading volatility implied by high VIX numbers that has folks spooked. Long term investors who typically look for a substantial margin of safety in picking stocks are afraid that an unexpected market correction will wipe out the safety margin the day after they purchase. Options traders are likewise concerned that well thought out options trading strategies will go for naught in a crazy market. With the prevailing sentiment being one of doubt, one might think of a hall of mirrors where a reflection is infinitely returned, smaller and smaller, and smaller. Since no one is trusting fundamentals they are watching each other and the very volatile market.

There can be substantial profit to be made in a volatile market and there is risk. Those who believe that the market will quiet down will be selling calls and puts and expecting to collect premiums right and left. Those who really believe that a given stock will settle into a price range will sell puts and calls, namely engage in a short straddle options strategy. Those who believe that the current degree of volatility will continue for another year or more will be stick with buying puts and calls. In fact, if one believes the currently volatility is as likely to drive a stock price up as down a long straddle options strategy is possible. The options trader will profit from either an up or down move and the only risk will be the cost of the premiums. Depending upon what happens with stock volatility one strategy or the other will be successful. For the trader new to options a caution is that buying options may or may not be profitable but the trader only loses the price of the premium in a losing investment. Although those who sell options tend to make more money over time a single bad trade can have devastating consequences with bankrupting losses. As usual we are not suggesting either strategy but rather suggesting a way of thinking through the current spate of options trading volatility.

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