Crisis Options Trading

T.D. Thompson — Mon, 31 May 2010 01:35:14 +0000

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Crisis options trading is emerging as European debt worries continue and investors ignore promising US job data. In times of great volatility and brewing crisis options traders tend to use strategies such as a long straddle where they buy both a call and a put on the same stock with the same expiration date. In crisis options trading the trader is not sure which way the market will go but is certain that volatility will take it one way or the other. Also in times of crisis traders typically sell their stock and deal almost exclusively in options until the current storm blows over. The Chicago Board Options Exchange (CBOE) volatility index, the VIX, has been high recently, hitting a peak on May 7. The VIX is often referred to as the anxiety index and high numbers often lead to crisis options trading.

Many traders are forsaking covered options trading as they are selling their stock. However, because very few traders are interested in selling puts or calls because of the uncertainty of the market the stampede to uncovered options trading does not really matter. No buyer has to execute a contract unless he or she will profit and then the trader will simultaneously execute the contract and execute a covering trade, pocketing the profit. In times of great market volatility such as these the only ones selling options contracts are the large institutional investors with really deep pockets and even those folks seem to have backed off a bit.

The use of a long straddle options strategy in crisis options trading works to provide opportunity at limited risk. It is one means of implementing risk management in option trading. The trader believes, based upon both market fundamentals and technical charts, that the market is set to move up or down, perhaps dramatically. By buying both a put and a call on a stock the trader is assured of a profit either way the stock moves. The risk is that the market will stabilize and the trader will be out two premiums. Timing can be everything in crisis options trading. It is important that the options expirations dates for contracts purchased in this type of trading are far enough out that whatever is going to happen will have time to happen. There are few things worse than buying a cheap options contract that has a few days to go and then having the stock price move dramatically the day after the contract expires.

There are different kinds of options trading for different times and different purposes. A more conservative approach is often warranted in times of pending economic crisis. Despite a well publicized trillion dollar aid package aimed at supporting debt repayment in the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries. Thus we see than many traders are divesting themselves of their stock and only buying options. Thus they have a large cash position and the option to buy stock or sell stock at the strike price should the spot price move substantially up or down.

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Crisis Options Trading

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