Lincoln’s 200th Birthday

AddendumI cannot believe I did this, but I really thought it was February.  Humble apologies.

Today is the 200th anniversary of the birth of Abraham Lincoln.  I doubt that has any stock market significance, but it's noteworthy.

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Readers of this blog and/or The Rookie's Guide to Options know that the strategy I've been using – more than any other for the past few years – is the iron condor. An iron condor is constructed by selling a call spread and a put spread on the same stock or index.  This method works best when the underlying asset trades within a range, rather than making large, one-directional moves.  Thus, 2008 was not a good year for most iron condor traders – unless that trader exercised excellent risk management.

One specific risk-reduction method that I've advocated is combining the purchase of iron condors with the purchase of out of the money puts and calls.  I've discussed this topic previously, but the reason for mentioning it today is because buying those strangles becomes attractive when options are inexpensive.

Thus, the question:  Are options cheap today?  No one knows the answer because the value of an option depends on the future – i.e., the volatility of the underlying, between the time you buy an option, and the time it expires.  Thus, the answer: it depends on how volatile you expect the markets will be, going forward.

It's an interesting dilemma.  On one hand, we are observing markets that are far less volatile than have were just a couple of months ago.  To some traders that means options are quite cheap – just because they were priced so much higher not long ago.

On the other hand, markets are still much more volatile than they have been over the past twenty years.  To some that means options are still expensive.

I have no insight, but I'm not yet prepared to bet on volatile markets by buying extra options.  I prefer to keep risk under control by trading fewer contracts.  If you are a premium seller, deciding position size is always a major factor when it comes to managing risk, and that it turns determines how successful your trading will be.

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4 Responses to Lincoln’s 200th Birthday

  1. rluser 01/12/2009 at 10:24 AM #

    Feb 12. Oops.

  2. Mark Wolfinger 01/12/2009 at 11:13 AM #

    I cannot believe I did that. I really thought it was Feb 12.

  3. rluser 01/12/2009 at 2:25 PM #

    I am impatiently awaiting next Monday, but still letting February come on its own terms.

  4. Mark Wolfinger 01/12/2009 at 3:05 PM #

    The biggest risk with January index positions is the Friday morning settlement. Be wary of holding longer than Thursday’s close, if you own such positions.