A Discussion About Volatility. Brave New World

It's a brave new world. 
  There's nothing about the current stock market that resembles previous markets. We've seen market volatility before, and we've seen greater daily percentage price changes – but this time there are so many gigantic moves that we can no longer suggest such days  are unexpected.

It was just two weeks ago that we recorded the largest one day decline in market history; an astounding 777 DJIA points.  And yesterday, the largest one-day move in history – a rally of 936 points.  On top of that, last Friday the daily range from high to low was more than 1,000 DJIA points.

To anyone who bought straddles, all I can say is congratulations.  The cost of owning options was so high, that I was never tempted to buy any (I was lucky enough to have bought enough when IV was much lower).  Yet, as pointed out by Adam at Daily Options Report, it's not the implied volatility that matters when owning front-month options, it's the size of the move made by the underlying stock or index that determines your results.  And option buyers have certainly done well.

What To Do Now

I can offer no advice about whether you should be long or short in this market, but what I do know is that safety is paramount.  If you want to bet on continued market volatility, it may be okay to buy a few straddles or strangles.  But that's not for me. 

I'm staying with my iron condor program, but am finding ways to buy extra calls and puts so that I own protection if the market moves far enough to hurt that position.  I'm also trading fewer options at one time, and that's a great way to cut risk.

Good trading to everyone.  It's treacherous out there – or not, depending on your gamma position.  If you own positive gamma, you've got to love the excitement of this market.

If you're an individual investor with mutual funds, stocks, and/or a 401k plan, this hasn't been fun.  But it's not too late to learn to use options as tools to reduce risk – now and in the future.  If you're a nervous investor, you owe it to yourself to learn about the advantages of using options.  Download my two free ebooks to get a basic understanding of how options work and a sampler version of my book for option rookies.

135

One Response to A Discussion About Volatility. Brave New World

  1. Antonio 10/14/2008 at 8:32 AM #

    Hi MArk,
    It´s possible to explain in an article abuot how do you do protect your IC with extra calls or puts?
    I mean to explain the moment you do and the strike you choose related to the IC
    Thanks.
    Antonio.