Volatility is back and options traders love it
Wed Aug 1, 2007 6:43PM EDT
CHICAGO (Reuters) - While Wall Street shed its share of tears last week, some options traders on Chicago's LaSalle Street smiled all the way to the bank.
As U.S. stocks tumbled last Friday and the Standard & Poor's 500 index (.SPX: Quote, Profile, Research) booked its worst weekly loss in almost five years, the surge in volatility gave traders like Brian Stutland a week to remember.
That's because Stutland trades futures and options on Wall Street's main barometer of investor fear, the Chicago Board Options Exchange's Volatility Index (.VIX: Quote, Profile, Research), known as the VIX.
In Stutland's corner of the U.S. equities index market, the return of big market swings spells "jackpot" as stock uncertainty is traded as an asset.
"Last week was definitely one of the best weeks I have had compared to the past year of trading options on the VIX," said Stutland, an independent options market maker at Cassandra Trading, an options trading firm at the CBOE.
"There is no question that it was profitable for me as volatility came back with a vengeance," Stutland told Reuters in a telephone interview.
VIX AT 4-YEAR HIGH
Volatility remains the name of the game this week, with the VIX closing at 23.67, after climbing to a fresh 52-week high of 26.22 -- its highest level since April 2003. On Tuesday, the VIX jumped 12.7 percent to close at 23.52.
The three major U.S. stock indexes swung wildly throughout Wednesday's session. The blue-chip Dow Jones industrial average (.DJI: Quote, Profile, Research) surged around 180 points late in the session, climbing from a point where it was down about 30 points and then roaring higher to close up 150.38 points, a gain of 1.14 percent, at 13,362.37.
During the session, the Dow gyrated 260 points from its session high at 13,393.02 to its intraday low at 13,132.65.
The re-pricing of risk is reflected in the high VIX, which measures anticipated stock market volatility conveyed by S&P 500 index (.SPX: Quote, Profile, Research) option prices.
The indicator tends to rise when the S&P 500 falls, reflecting more angst as investors bid up options to protect their portfolios. On Wednesday, the S&P 500 also changed direction dozens of times to finish up 10.54 points, or 0.72 percent, at 1,465.81.
ROOM FOR FEAR GAUGE TO RISE?
The VIX has been grinding higher since mid-April, coming out of its slumber when it ranged between 10 and 14 in the six-month period through February 27. On that day, the Dow average slid more than 400 points in a global sell-off triggered by a drop of almost 9 percent in China's benchmark stock index.
Last Friday, the VIX surged to 24.2, which was its highest closing level since April 2003 as the U.S. stock market sold off on investors' worries that losses in the subprime mortgage market may spill over into the broader economy.
The Dow and the S&P 500 lost more than 4 percent last week, with Thursday's huge equity sell-off wiping out more than $300 billion of investor wealth in the S&P 500 alone. A steady stream of news about the worsening global credit environment topped investors' worry list.
This week, Stutland said he is maintaining a neutral stance although he believes the VIX could go higher.
"I believe the credit concerns have already been priced into the market right now," he said.
Stutland is awaiting Friday's jobs report for July, which could give more clues about the economy and interest rates.
SWING TIME
For just over a year now, Stutland, 32, has been trading VIX options, which give investors a way to bet on the expected rise or fall of fear in the market.
As a volatility trader, Stutland could not be happier.
"As a VIX options trader, you don't really care whether markets go up or down. The key is whether it is volatile," he said. "The crowd in the pit does not bet on the direction of the stock market. It bets on the magnitude of the move."
Stutland still believes last Friday's sell-off was the start of a small correction in the market.
"What you want to see is an extreme spike in the VIX, which we saw on Friday and again this week. This can be an indication that the bears have oversold the market," he said.
Stutland, who is also an adviser at MWS Capital, a private investment firm in Chicago, said owning volatility in the form of VIX options can help investors hedge a stock portfolio against these big swings in stock prices.
Investors can buy VIX calls in anticipation of greater stock market volatility or puts if they believe the VIX is heading lower on the idea the market is turning toward greater complacency.
Options turnover on the VIX has been active with the return of volatility. In mid-July, the CBOE reported that VIX options volume surged to an all-time high of 322,484 contracts.
VIX options were the CBOE's second-most actively traded index product behind its top contract -- S&P 500 options.
"It's hard to imagine that options on the VIX will become more popular than options on the S&P 500 index, but for now they have certainly caught investors' attention as a truly viable hedge against rising uncertainty in global markets," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group, in Greenwich, Connecticut.
Futures contracts tracking the VIX on the CBOE Futures Exchange also show volatility isn't going away any time soon. VIX futures on Wednesday traded as high as 21.00.
"That is still a high level for the VIX, compared to the last two years. Volatility is here to stay," said Dominic Salvino, designated primary market maker at Group One, an options trading firm at CBOE.
"Traders are still worried about further declines in the market," Salvino said. |
