Option Trading Idea of the Week
The most popular measure of the Implied Volatility of option prices is the VIX which is the average volatility of options on the S&P 500. It is commonly referred to as the "fear index" because it tends to go up when stock prices fall and go down when stock prices go up. When stock prices do nothing, VIX tends to get very low.
To get a reality check on how unusual the present conditions are in the options market, check out the following graph of VIX over the past 5 years:
During the fall of 2008 and the first quarter of 2009, VIX was higher than it had been in the history of the stock market. This made it quite difficult for us to make gains in our portfolios that do best in a flat market. A year ago, we correctly predicted that VIX would fall (this really is one of those things that must go down after it goes up so high, so it was an easy prediction to make).
Just about the best strategy when VIX is falling is the short iron condor, and that is exactly what we added to our portfolios in early 2009. The results were extremely positive. When VIX fell to 30, we stopped doing short iron condors because VIX did not have too much further to fall, and we expected that our preferred strategy of multiple calendar spreads would outperform if VIX stabilized rather than continuing to fall (it was about 22 at the close on Friday).
When VIX is as low as it is right now, it is difficult to get a decent price for a short iron condor, and if volatility kicks in once again as it often does, you could have some big losses in condors. We found in earlier years when we traded iron condors extensively that we made money in about 6 out of 7 months but in the seventh month the loss was as great as the total gains in the previous six months. Maybe other people are smart (or lucky) enough to make money with short iron condors, but we couldn't, except during times when VIX was falling.
We hope that VIX will hang out about where it is right now. A few months of a sideways market could do miracles for our portfolios. The last three months have all been extremely good ones for our portfolios, and we will keep an eye on this important indicator of market action to help lay plans for future months.
In case you missed the videos I offered over the past few weeks, you can catch them here by clicking on the title you missed -
In case you missed the earlier videos, you can catch the first one here:
- Why Stock Options are Better Than Mutual Funds.
- How to Create a Conservative Options Portfolio.
- How to Use Options to Invest in Gold.
- Making Adjustments to a Conservative Options Portfolio
Any questions? I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.
You can see every trade made in 8 actual option portfolios conducted at Terry's Tips and learn all about the wonderful world of options by subscribing here. Why wait any longer to make this important investment in yourself?
I look forward to having you on board, and to prospering with you.
Terry
Andy's Market Report
In a week where the headlines were once again dominated by the ongoing saga of Tiger Woods the market was able to wear off some of the short-term overbought conditions while holding mostly flat. It has now been four weeks where the market has traded in a fairly tight range. Once this range is broken we might just see a nice directional move. As to which direction that might be, well, that is up for grabs. However, when trading premium-selling options strategies a flat market is often the best.
The S&P 500 (SPY), Dow (DIA), Nasdaq 100 (QQQQ) and Russell (IWM) finished the week mostly flat 0.0%, 0.8%, -0.2% and -0.4%, respectively. For the year, the S&P 500 is up 22.5%, the Dow has advanced 19.3% and the Nasdaq is leading the way with a 38.9% gain.
The week was filled with volatility. Tuesday session sharply lower and two days later, Thursday session saw the market advance sharply higher.
The decline on Tuesday can be attributed to Moody's report stating that although the financial crisis was nearing an end, triple A rated nations such as the US could struggle to find money to reduce public debt.
"The global macroeconomic and financial system crises may be close to an end, but the fiscal crisis in a number of AAA-rated countries will likely last for several years," Moody's Investors Service said in a key report.
"Among the challenges to major AAA-rated nations like the US, UK, France, and Germany will be the pace and sustainability of economic growth and future interest rate trends, both of which affect the countries' ability to manage the significant debt burdens they have assumed as a result of the crisis.
Thursday's advance came on the heels of a positive Trade Deficit report. Thanks in part to the weakness of the dollar and low demand for foreign oil, the U.S. trade deficit plunged by 7.6% in October to $32.9 billion, as a surge in exports overwhelmed a slight uptick in imports, the Commerce Department said yesterday.
On the technical front, the major benchmarks are sitting comfortably in a neutral state so there really isn't much short-term advantage towards the bulls or bears. We do typically see strength during this time of year - typically known as a Santa Claus rally and I think this might be one of those years where Santa is kind to market participants.
Moreover, we are entering the week of options expiration which is historically a bullish affair. It certainly would not surprise me to see the bulls take the reigns this week and if they do I will be watching to see if they can break the recent highs and hold those levels. If so, I think Santa might come early this year for those of you leaning towards the bullish camp.
Next week the focus will be on the FOMC meeting Wednesday. Stay tuned, it could be the catalyst that finally moves the market out this four week consolidation period. Of course, only time will tell.
Andy
Overbought/Sold Condition Report
Overbought/Oversold as of December 13, 2009
Major Benchmarks
- S&P 500 (SPY) - 60.9 (neutral)
- Dow Jones (DIA) - 67.5 (neutral)
- Russell 2000 (IWM) - 60.0 (neutral)
- NASDAQ 100 (QQQQ) - 55.5 (nuetral)