Be Aware Of Volatility Warning Signs!
Option volatilities have risen
significantly in December options over the last month.
This severely handicaps buyers of options if the market slows down
through the holiday season.
Here
are some examples where December options have risen significantly and a preview
of what could happen if the market slows down:
| Stock/
Price |
Dec.
At-the-$ Strike |
Option
Price |
Option
Volatility Now |
Probable
Option Pr. During Slowdown |
Probable
Volatility During Slowdown |
| AOL-49 1/8 | 50 | 3 1/4 | 63% | 2 1/2 | 50% |
| CMGI-14 1/16 | 15 | 2 1/4 | 160% | 1 5/8 | 125% |
| CIEN-101 | 100 | 13 | 108% | 11 | 90% |
| DELL-26 | 25 | 2 3/4 | 73% | 2 3/8 | 60% |
| CPQ-26 5/8 | 27 1/2 | 1 5/8 | 63% | 1 1/8 | 48% |
| INTC-42 1/8 | 42 1/2 | 3 1/8 | 67% | 2 9/16 | 55% |
| MU-33 3/4 | 35 | 3 1/4 | 97% | 2 3/8 | 75% |
| SUNW-95 | 95 | 8 3/8 | 75% | 6 3/4 | 60% |
A
couple of notes about the above information. The Probable Option
Volatility was estimated by looking at where four- to five-week options in these
stocks
have traded over the last six months. Four to five weeks is what is left in
the December options. Probable Option Price was determined by plugging the
probable option volatility into a probability calculator.
What does this mean for the individual retail
trader? They should be very aware that they are paying $1/2 to $2 of “juice”
(extrinsic value) if the market does slow down. If they are correct and
receive quick, strong movement in their security, that will make up for the
additional extrinsic value. Otherwise, they are paying too much.
Bullish Strategies that take advantage of high
volatility:
-
Bull
Spread – Buy in-the-money, Sell at-the-money -
Put
Bull Spread – Buy out-of-the-money, Sell at-the-money -
Long
Time Spread – (If the January volatility hasn’t gone up
significantly over the last month) Buy January at-the-money, Sell December
at-the-money