How To Play The War Waiting Game
At this point, there is little doubt the we are going to war with Iraq. However, as the US seems increasingly willing to wait for a second UN
resolution on the matter, the war will have to wait for a few more weeks — at the
earliest. One potential way to profit from this scenario is through a
limited-risk, equity index option strategy.
All of the current geopolitical uncertainty is keeping implied option
volatility at higher-than-normal levels. Therefore option premiums, generally
speaking, are more expensive now than during more certain times, since the
market thinks that the contract writer should be better compensated for the
additional event risk.Â
This scenario allows certain participants, depending on
their view, the chance to make some profits. For instance, if you are wed to a
long equity index position; or if you think that the market isn’t going to trade
sideways, or drift lower over the next couple of weeks, consider selling a 1-month call spread (selling an at-the-money call and buying an out-of- the-money
call)Â against the equity index of your choice. Since you sold the spread,
you keep the premium if the market closes below the at-the-money short strike.
The maximum loss on the trade is the difference between the short strike and the
long strike. And, in the example of the person who is wed to a long
index position against the short spread, he/she won’t make any money between the
two strikes, but will profit once the market goes above the higher out of the
money strike but will lose money on their long index position.     Â
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Sell an SPX March Call with an 830 strike (at the money)
Buy a SPX March Call with an 870 strike (out of the money)
The 870 level on the S&P cash cart is a pretty decent resistance level.
Should the market trade above the 870 level over the next couple of weeks, it
would probably continue up in a pretty dramatic way. And the long option would
cap any continued losses on the upside.   Â