UPDATE:Volatility Index Jumps As Egypt, Nasdaq Glitch Add To Unease
January 28 2011 - 4:31PM
Dow Jones News
The stock market's "fear gauge" leapt to its highest level in
nearly two months Friday. But for some options strategists, it is
the wrong time to hide in a bunker.
Traders reached for protective options as they eyed the trio of
unrest in Egypt, disappointing bellwether earnings and Nasdaq OMX
Group Inc.'s (NDAQ) index glitches. As stocks slid, the Chicago
Board Options Exchange Market Volatility Index, or VIX, surged as
much as 23% to levels not seen since Dec. 2. The VIX tends to jump
when stocks fall.
Volume in put options swelled across the market.
"You have to take advantage of pullbacks," Oppenheimer & Co.
chief options strategist Michael Schwartz said. Options traders
should consider selling put options on stocks they find attractive,
Schwartz said, which lets traders collect premium income before
owning shares they plan to buy anyway. If the shares don't fall
past specified levels, traders keep the premium income, and won't
be required to buy the stock.
Big block-order put sales crossed in options on glass-container
maker Owens-Illinois Inc. (OI) and the Materials Select Sector SPDR
(XLB) exchange-traded fund, among others. An anxious day such as
Friday is "the perfect opportunity to sell puts, to my mind,"
Schwartz said.
The natural tendency in an anxious market is to buy those
bearish and protective contracts.
"The immediate knee jerk is to (buy) options premium, looking
for that pullback, and that's driving volatility," Interactive
Brokers senior market analyst Andrew Wilkinson said.
Options traders should generally aim to sell into rising
volatility levels rather than buy options when premiums are high,
Wilkinson said. One strategy is to sell call options against the
purchase of preferred stocks, he said. This is another
premium-collection strategy that takes advantage of higher "implied
volatility" in options prices.
At the same time, strategists said more risk-averse traders
could stand to wait a session or two. "When the market starts
falling, it falls under its own weight, and that boosts the VIX
even further," Wilkinson said. "If by Tuesday the VIX has gone
through 20, people will be more inclined to say that we've had an
aberration in this recent period of low volatility, and we're
getting back to normal," he explained. With the S&P 500 down
1.8% to 1276 in afternoon trade, the VIX was up 21% to 19.49.
The ratio of bearish S&P 500 puts to bullish calls leaned to
puts. Traders picked up 530,000 S&P 500 puts compared with
228,000 calls, data from options analytics firm Trade Alert showed.
The last month's S&P 500 put-call ratio was much lower.
The day's slide in stocks surprised even some in the Chicago
Board Options Exchange's VIX options pit, where traders specialize
in market volatility.
"There was a slight feeling of panic with the second down leg of
the S&P 500" in the late morning, said Dominic Salvino, a
specialist and VIX options market maker at Group One Trading.
-By Brendan Conway, Dow Jones Newswires; (212) 416-2670;
brendan.conway@dowjones.com