I had the pleasure of talking with WSJ Marketbeat reporter David Gaffen this week about our new-favorite topic on this blog, the Volatility Index or VIX. The resulting article, “For the VIX, 50 is the new 30”, is a must-read to help put these roiling markets into historical perspective.

(If you’re just catching up, I’ve posted a bunch about the VIX this fall in light of recent, unprecedented market activity. Start with this post about the VIX itself, or move on to my post about binary options on the SPX and VIX.)

Gaffen highlights a troubling fact about the VIX’s current high levels: they may not even be high enough. As he writes: “The VIX has remained uncharacteristically high, but not without reason. The S&P 500’s realized volatility (that’s the recent past, as opposed to the VIX, which is a look at the near-future) show that the VIX is actually lagging the market’s volatility.”

This produces a chain reaction that’s made life difficult on options traders lately: options are very expensive lately due to high volatility, making it tough to buy in. In turn, it might explain some weird contrarian moves. As Gaffen explains, “If a purchase of call options, that is, a bet on the S&P 500 rising, should come true, volatility will decline, and with that the value of the option, making a winning position a potential loss.” Stop scratching your heads, folks: there’s a method, albeit a strange one, behind this madness.

What’s working for you in these crazy conditions? Are you sitting this one out, or have you found ways to ride these waves? Send ‘em my way, please! I’d love to get a conversation going where we share and share alike.

Regards,
Brian (OG)

[image: The WSJ logo from their website]

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.

Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.  

Please be aware that early assignment of short options on American style expiration options may affect the overall max profit and loss potential of the strategy. Please plan accordingly for this possible occurrence.

It is possible to argue volatility (VIX) is the only bull market left in town. One way for a trader to try to capitalize may be selling naked puts on cheap shares. GM DEC 2.5 put sold last week for $0.73. It is really a binary option - the shares go to 0 or something else. The IV of these options > 300%

Implied volatility (IV) does make us all tempted to sell anything and everything.  The scary thing is the panic the IV has implied has been correct. If you were to look back at the implied volatility compared to the historical (HV) over the past couple of months on the SPX index it has been pretty accurate, in a lot of the cases with individual stocks the IV has been low comparatively to HV. What I am implying is that the buyers of options have done better then the sellers in the last few months (assuming they got the direction right). With your specific trade you make a very solid point that you basically have a “free” zero strike put as a hedge, this definitely helps to have defended risk in this type of market.

 

Regards,

 

Brian (Og)

 

DISCLAIMER: While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct. Special risks are involved with uncovered options writing that may expose the investor to potential losses.

Option plays can be strange indeed.  Many calenders or time spreads now are profitable in this wild volitility with strange skews allowing a playable volatility play with the front month having higher volatility than the back month.  Many of my friends trading them have been succesful.  For me I dont like to trade them for a potential volitity crush and have seen that bad movie before with some of my positions.  However after reading this and other articles I am beginning to wonder that I should be.

Sorry, I did not mean to imply that selling volatility is the only way to trade VIX > 70. And Brian is correct, so far this was the wrong trade. I was one of the "conventional wisdom" guys who shorted the VIX when it reached 30. A lot of pain involved :-(

Hello All,

Here is a link to a great article that I contributed to. It is written by Rebecca Darst from thestreet.com. It gives a lot of insight into the current markets.

"Fear and Loathing in the Options Market"
http://www.thestreet.com/story/10448716/2/fear-and-loathing-in-the-options-market.html

Inside this article one quote really jumped out at me.

Kevin Fischer, head of the block trading desk at Interactive Brokers, explains it thusly: "In a time of protracted high volatility, such as what we've experienced the past two months, option traders may find that their normal trading strategies do not work, and often lose money before heading for the sidelines. This also creates a kind of no-man's land, of shrinking volumes and wider markets, where option traders don't care to be long volatility, because they know eventually it will return to historical levels, but don't want to be short either because they know it can still go higher."

This is exactly what is happening in the option markets right now.

Regards,
Brian (Og)

DISCLAIMER: While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct. Special risks are involved with uncovered options writing that may expose the investor to potential losses.