Options Trading Idea of the Week
A Look Back at VIX:
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:
Five- Year Graph of VIX
This chart clearly shows that we are in truly unusual times. Two years ago, VIX was at 10, and now it is about 45. For the past 5 years, it has remained under 20 the great majority of the time. The surge to 80 had never happened in the history of the market before.
Where will it go from here? Of course, we can't know for certain. A good guess would be to say that it would head in the direction of the historic levels at some point. However, the uncertainty about the economic picture should be expected to continue for several months at least. If that is true, we might see VIX fall to the 30 range before it levels off rather than seeing it level off nearer to the sub-20 line of prior years.
Since short iron condors are the spreads of choice for a market when option volatilities are falling, we will continue to maintain condors as an important part of our portfolios until a lower VIX comes into being.
Terry
Andy's Market Report
Well, where do we start? I guess stating that Friday officially marked the end of the worst January in market history. The S&P (SPY) and Dow (DIA) lost 8.6% and 8.8%, respectively.
"As January goes so does the year". The proponents of the
January Barometer suggest this is a market omen for the remainder of the year, and they might be right. Statistically, the study reports a 90% accuracy rate. Yale Hirsch of the Stock Trader's Almanac writes that "the incredible January barometer" has made only 5 significant errors in the last 59 years. However, I must point out that while the study is indeed accurate it must be pointed out that the five worst Januarys were followed by an advance in the S&P over the next 11 months. Oh yeah, and I did say that this was the worst January on record.
Anyway, it was the fourth straight losing week for the market and one that witnessed more trouble on the economic front. Bad economic data and more cautious earnings guidance were expected, but the ongoing indecision in Washington was not.
The Government Accountability Office (GAO) stated that "the lack of a clearly articulated vision has complicated Treasury's ability to effectively communicate to Congress, the financial markets, and the public on the benefits of TARP".
As we all know markets hate uncertainty and until the next wave of TARP funds have been decided on I expect to see more range-bound trading.
As for the economic news, well, it continues to be dismal. To start the week it was reported that home prices fell 9.3% in 2008. Consumer prices came next with the lowest reading on record, followed by a record high in jobless claims. Moreover, durable orders declined for the fifth straight month. To top off the week of poor economic data Q4 GDP reported a drop of 3.8%.
"We expected fourth quarter to be the worst of the recession," said Randy Frederick, director of trading and derivatives at Charles Schwab. "From an investor's perspective, they may see this stronger-than-expected report setting us up for the first quarter to be worse.
"Everybody is trying to figure out how to survive," said Brian Bethune, economist at IHS Global Insight.
On the technical side of things, the S&P continues to be stuck in the 800-860 range. Quite a few directional traders have become frustrated by the lack of conviction lately and until the aforementioned is broken and successfully retested I think we should expect more of the same.
Seasonally speaking the last two trading days of January and first five trading days of February have been overwhelmingly positive for the market with 17 out of the last 20 years. If that is the case and history does happen to repeat itself this time around we should expect to see some decent gains next week. The overbought/oversold readings are currently in a neutral state so there is no short-term edge there. So, who knows, maybe history will win once again.
Overbought/Sold Condition Report
Overbought/Oversold as of January 30, 2008
Major Benchmarks
- Dow (DIA) - 35.7 (neutral)
- S&P 500 (SPY) - 38.7 (neutral)
- Russell 2000 (IWM) - 40.0 (neutral)
- Nasdaq 100 (QQQQ) - 43.8 (neutral)
- Oil Services (OIH) - 47.8 (neutral)