Weekly Stock Options Trading Tips: March 8, 2010

Stock Option Trading Idea of the Week

It's About that Falling VIX

As most of you know, VIX is the volatility measure based on option prices of the S&P 500 tracking stock, SPY. It has fallen all the way to 17.42, the lowest level we have seen in over a year. (Remember that it got as high as 80 in the fall of 2008?) VIX has fallen 17 of the last 18 days.

VIX is the so-called "fear index," and historically has moved higher when there was uncertainty (or lower stock prices) in the market. So where has all the fear gone? There are a huge number of uncertainties in the current economic world, both at home and abroad, and the market seems to be ignoring them at this time.

Over the years, VIX has shown a strong inclination to revert to the mean, and the mean is about 20. I think it is inevitable that VIX will climb back up toward, or above, 20 in the near future. In fact, I have put my money where my mouth is, and bought a vertical call spread on VIX for April that will make a gain at any price of VIX above 19.

An interesting trade might be to buy a VIX March 17 call (currently bid $1.60, asked $1.80) placing your buy order in the middle, at $1.70, and to sell a VIX March 20 call (currently bid $.55, asked $.65), placing your sell order at $.60. (I have been successful getting prices half-way between the bid and asked for VIX options.)

This spread would cost $1.10 if you could get it at those prices (plus another $.03 in commissions). VIX would have to close above 18.13 in two weeks to make a profit on the trade. If it managed to go all the way back to 20, you could earn over 100% on your investment.

A safer bet would be to do the same spread for April, although it would naturally cost more since there would be more time for VIX to return to its more "normal" level of 20 (especially during uncertain times).

The second half of March has historically seen lower markets. If that is the case this year, VIX should shoot higher, and make these vertical call spreads profitable trades.

Since a lower VIX means that you would lose on these spreads, perhaps everything you invested, you should only buy them with money you can truly afford to lose.

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:

• 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

The market surged again this past week on low-volume, but nonetheless the advance was impressive. The small-cap Russell 2000 (IWM) lifted 6%, while 91% of the stocks that make up the broad market index S&P 500 (SPY) advanced which helped to push the index higher 3.1%. All of the major indexes erased their losses for 2010 during the week.

For most of the week market participants waited in anticipation for Friday's unemployment report. The Labor Department's monthly unemployment report is seen by many economists as the most important measure of the economy's health. A decline in unemployment is necessary for the economy to make a sustained rebound.

Although the U.S. continued to shed jobs during the month of February it was better economists predicted. Employers cut 36,000 jobs, but the forecast was for a cut of 50,000. The unemployment rate held steady at 9.7%. Economists' expected it to rise to 9.8%.

"We haven't won the game yet," said James Meyer, chief investment officer at Tower Bridge Advisors. "We're just getting back to neutral. You can't get from negative to positive without crossing zero."

"A healthy job market in the US is one in which ... unemployment is around 3-1/2 to 4 percent," Mr. Burtless of the Brookings Institutions states. "In this particular recession, the number of people affected by unemployment has been extremely high."

He adds, "The hours of work have slumped, which means we do have an exceptionally high number of people in part-time positions who want to be full-time."

The upcoming week marks the one-year anniversary of the market's rebound. On March 9, 2009, all of the major stock indices declined to 12-year lows as concern grew about the economy. Many market participants state that It was Citigroup Inc.'s report that it had made money in early 2009 that helped jump-start the recovery.

However, Wall Street will have to overcome quite a few bearish technical scenarios if it plans to move forward. Over the short-term (1-5 days) the technical situation looks ominous for the bulls as all of the major market indices have pushed into a 'very overbought' state. Furthermore, the RSI Wilder (2) for the tech-heavy NASDAQ 100 has move to 99.6 which is close to a historical level. This typically signals a short-term reprieve going forward. Also, the major market benchmarks are back at previous highs which should help to act as an area of strong overhead resistance. If that wasn't enough we have not one, but two unclosed gaps that occurred during the week. Combine all of the aforementioned and I think we could see a short-term bearish move next week. Of course, there are no certainties, but the probability of a move to the downside heavily outweighs an advance for next week.

Andy

Overbought/Sold Condition Report

Overbought/Oversold as of March 8, 2010

Major Benchmarks

• S&P 500 (SPY) - 89.8 (very overbought)

• Dow Jones (DIA) - 86.4 (very overbought)

• Russell 2000 (IWM) - 91.8 (very overbought)

• NASDAQ 100 (QQQQ) - 90.7 (very overbought)