From THESTREET.COM's Option Forum:
Without giving too much space to the competition, Barron's quoted an idea on how to play a potential collapse in the market, and the resulting volatility, from options strategist Don Fishback using straddles: "Investors ought to put on trades that will profit from a flurry of volatility in either direction, namely straddles, the simultaneous purchase of both a call and a put on the same stock at the same strike price. Straddles should end up in the black as long as the move in the underlying stock exceeds the combined cost of the call and put."
What Steve noticed, Benowitz points out, is that most options will see their historical volatility "regress to the mean," or return to usual levels. Fishback, he adds, seems to think every option's volatility is going to go through the roof when and if the stock market careens downward.
"It's scattershot logic," Benowitz says. Rather than invest in options with historically low volatility, why now get into America Online (AOL:NYSE) at a point when it has hit a historically low volatility that is bound to come back?
Secondly, he adds, "I wouldn't buy straddles in this case. All that does is allow the traders to sell more options; it's a fatter trade and commission for them. I would instead selectively buy puts."
Why? "Puts are one of the underrated plays of the last five years because of the go-go stock market," Benowitz explains. "And an even more underrated trade is picking out cheap puts in stocks that have the ability to get crushed."
For example, take October 100 puts and calls on IBM (IBM:NYSE), which trade for 2 ($200 per contract) and 26 ($2,600), respectively.
"For that money, why not just buy 10 times as many puts, if your premise is that the market will get hit? That way, 100 puts will make you more money than 10 straddles."
For retail investors, straddles can be expensive. "First of all, straddles can be sucker bets. When and if the market collapses, of course, that fall will pump up volatility in options prices," Benowitz says. "But why not just buy puts? It's cheaper, safer and less capital intensive since you put less money to work." |
