Evaluating Wall Street's Options
Options News by Better Trades
As Wall Street continues to rally in the face of downbeat macro data and a tornado
of economic instability, the options market is heating up with investors remaining
cautious on calling a bottom in the stock market.
Previously dirt-cheap call options contracts have picked up in value over the past
week on the surge in a swath of equity prices. For example, the bid-ask spread on
Citigroup's April 2009 $3 calls rose to $0.39-$0.40 as of March 16th with the
underlying shares trading around $2.50. Prior to last week's rally, the same
contract was going for 1 cent when Citi traded at $1/share.
Call options activity has picked up elsewhere. In the wake dramatic M&A goings-on
in the health care field, Humana (HUM) experience above-average daily call volume
on rumors of an Aetna (AET) takeover. Interest in Frontier Oil's (FTO) April 17.50
calls picked up Monday morning.
While bullish option prices have climbed, put prices are generally declining but at
a slower pace than their call counterparts. This suggests options players are
reluctant to affirm that the rally has legs.
The Chicago Board Options Exchange Volatility
Index, or VIX as it is commonly known, is indicating that volatility in the S&P 500
index will decrease over the next 30 days. Since peaking above 52 in February, the
bank rally has helped smooth volatility with the VIX trading at 42. Putting it into
context, the VIX peaked just below 90 in October when systemic risk reached a fever
pitch. By the turn of the year, the VIX calmed to 38 but has spent most of 2009
hovering in the mid-to-upper 40's. When the S&P broke below 700 in early March,
the VIX shot above 52.
When security prices are experiencing huge percentage increases and decreases, long
straddles and strangles become attractive options strategies. A straddle involves
purchasing a call and a put on an underlying asset with the same exercise price
and expiration. A strangle involves purchasing a call and a put on an underlying
asset with the same expiration, but differing exercise prices. Both strategies
profit when the underlying security price moves dramatically and both lose money
when the price remains sticky.
Neutral options strategies like straddles and strangles limit risk to the purchased
options prices while retaining unlimited profit potential. When investors are
unsure of market direction, options can provide the luxury of a buffer against
uncertainty.
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