Last week the European debt crisis was apparently averted, at least in the eyes of option investors. VIX, the so-called "fear index", the average implied volatility of option prices on the S&P 500 tracking stock (SPY) fell dramatically to just below 25 (still above its mean average of about 20 but well below the 40+ it has sometimes been at during the previous month).
When option prices are high (i.e., implied volatility, VIX) is high, there are huge gains possible by writing call options (not our favorite ploy) or buying calendar spreads (our favorite most of the time). However, when actual market volatility is greater than the expected volatility (i.e., implied volatility of the option prices), writing calls or buying calendar spreads is generally unprofitable.
Over the last three months, we have had great difficulty making gains with our calendar spreads because actual market volatility was too great. On the other hand, we have had some luck with buying straddles (or strangles), a strategy of buying both a put and a call on the same underlying and hoping that there is a big fluctuation in either direction.
Last Wednesday, after following VXX (a "stock" that is based on the futures of VIX), we noticed that actual volatility was huge - it had fluctuated $2 or more almost every single day for several weeks. On Wednesday in one of our portfolios we made a small ($1400) buy of 5 VXX 43 puts and calls which would expire two days later. We paid $279 per straddle. When the market for VXX opened up sharply lower on Thursday, we sold the straddle for $596, netting 117% after commissions.
In another portfolio where we owned calendar spreads on VXX, we lost money. Our results in these two portfolios clearly demonstrated that when high actual volatility occurs, you do best by buying short-term options, either puts or calls depending on which way you believe the market is headed, or both puts and calls if you admit you really don't know which way it will go (as we usually do). On the other hand, when actual volatility is low, calendar spreads deliver higher returns.
Now that much of the uncertainty facing the market has subsided a bit, we believe it is time for the calendar spreads to prosper once again as they have for most of the past few years (since late 2008 extending up to August of this year).
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.
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I look forward to having you on board, and to prospering with you.
Terry
The market continues to amaze.
In less than four weeks, the Dow has risen 14.8 percent from its 2011 low, reached on Oct. 3. The S&P has gained 17 percent. However, the Dow remains 4.5 percent below this year's high, reached on April 29. The S&P is 5.8 percent below its high.
While I mentioned that the market was short-term oversold towards the beginning of the month I never thought the market would rally this far, this fast. The S&P pushed through 1200, then 1220, followed by 1250 and now it sits at 1285. Amazing!
But, now we are at a very important area of strong overhead resistance at 1300. My guess is that we will take a breather for the next 5-10 days and pullback to possibly the 1220 area before the end of the year "Santa Claus" rally begin to take shape.
Once the New Year passes, well, I think we could see more doldrums, but that is way too far out for me to discuss right now.
All of the major benchmarks and most of the sector ETFs I follow have pushed into a short-term "overbought" to "very overbought" state, so I expect to see a short-term pullback as we head into next week. However, the one piece that could hold this market up over the next few days is the overwhelmingly strong seasonal bullishness that resides during the end of October/beginning of September. Once the seasonality passes it is back to a tug of war scenario with 1250 on the S&P being the first area the bulls need to defend.
Markets have been roiled for months by fears about the impact of Europe's debt crisis. Greece couldn't afford to repay its lenders, and banks holding Greek bonds faced billions in losses. A disorganized default by Greece threatened to spook lenders to other countries with heavy debt loads such as Spain and Italy. Traders feared that a wave of defaults by countries would cause financial panic and mire the global economy.
But that was all alleviated on Thursday. Or was it? There are still plenty of obstacles to overcome before the crisis is resolved. One troubling sign: Borrowing costs for Italy and Spain increased, signaling that traders remain worried about their finances.
But for now let the bulls rejoice. But know, that the risk/reward is now on the downside. Typically, a bear market correction is sharp and furious. While, I am not completely sold on that contention I am leaning more towards the downside as we move towards November expiration.
Andy
I'm very satisfied and impressed with the autotrading as it's gone to date. I couldn't possibly keep on top of the adjustments as you do. I monitor the TOS risk graphs daily and enjoy reading the Saturday Reports. ~ Walter