Current Events for Options Traders
So far it's been quite a week to say the least. And there's still 2 more days to go! Last week I told you that the implied volatility in the Lehman Brothers options was telling us that LEH would be making a pretty big move. Once again, the options were correct. The problem is that there are now lots of stocks with implied volatilities over 300% indicating a lot more big moves coming up. The more I listen to the pundits explaining why things are happening, the more I believe the options. Lehman can't find a buyer so the Fed forces them to declare bankruptcy and the market crashes. Then, on the other hand, AIG is saved by an infusion of capital from the Fed and instead of the market reacting positively, it crashes some more. Seem like they're flipping a coin and can't win because both sides are tails.
Morgan Stanley (MS) and Goldman Sachs (GS) who both came out with earnings that were greater than expected and announced that they had sufficient cash reserves and working capital to make it through the current credit crisis were also hit hard. This year Morgan Stanley's shares are down by about 65%, while Goldman is down slightly over 50%. And here's the kicker; the implied volatilities on both are through the roof, not quite as high as LEH was, but still very, very high. To put this in perspective, the September at the money straddle on IBM which closed yesterday at $111.47, is trading offered at $4.40. Contrast that with the GS at the money straddle which is offered at about $20 with the stock at approximately $110 or the MS straddle at a whopping $7 with the stock at $21. Remember, there's only 2 days to expiration! The options are telling me that we're going to see a move. By the way, while the climate certainly looks like a move down, the implied volatilities are indicating a large move, but the direction isn't specified.
Adding to the fun, excitement and volatility of the markets is the fact that this expiration is “quadruple witching.” For those of you who are unfamiliar with the term, quadruple witching refers to the expiration day (third Friday of the month) in March, June, September, and December. On those days, index futures, index options, stock options, and single stock futures all expire. The last hour of the trading day on these expirations is called the “quadruple witching hour” and at this time traders attempt to unwind their positions before they expire and, as a result, add a tremendous amount of short term volatility to the markets. Hold on to your hats!
Aside from all that exciting stuff, there are some events that have recently been announced by various agencies that I think options traders will find interesting and should be aware of.
Naked Short Selling Rules – The SEC issued rules yesterday that add penalty provisions to the already illegal practice of naked short selling. Briefly, short selling of stock (not to be confused with short selling of options) is when a short seller borrows stock and then sells it with the expectation that the stock will decrease in price and that it can be purchased at a lower price and returned to the owner. A naked short sale happens when the seller doesn't actually borrow the stock and consequently fails to deliver it to the buyer. This practice is quite commonplace and some politicians are blaming the large stock market losses on this practice. Will the penalties be enough to curb the practice still isn't clear although SEC Chairman Cox has said that the issuance of this rule and other actions “make it crystal clear that the SEC has zero tolerance for abusive naked short selling.” It's too bad that it takes a crisis of this magnitude to get the SEC to do what they should be doing anyway. (Please excuse the political commentary.)
New Options Trading Volume Record – The Chicago Board Options Exchange (CBOE) announced that yesterday was the busiest day in its 35 year history. Over 9.7 million options contracts were traded beating the old record of 9.2 million contracts traded on August 16, 2007. Tuesday's volume was 8.6 million contracts which was actually the 3rd busiest day. To put those numbers into perspective, the average number of contracts traded daily on the CBOE was just under 3.8 million in 2007. The CBOE is the largest options exchange in the United States and account for about 35% of the options industry total volume in the US.
January 2011 LEAPS Start Trading – After a delay of several months, the January 2011 LEAPS started trading this past Monday, September 15th on options that trade on the January cycle. LEAPS for options that trade on the February cycle will begin trading on Monday, October 13th and those on the March cycle will begin trading on Monday, November 17th. This is a change from the prior policy where LEAPS were always introduced on the Monday following expiration. This new policy introduces LEAPS on the Monday prior to expiration.
The reason is to avoid having 2 expiration months start on the same day. To make this clearer, let's look at an example. For a stock that has options trading on the January cycle, on the Monday following September expiration, options with November 2008 and January 2011 expirations would be introduced (absent the delay that occurred this year.) Under the new policy, only the November options would be introduced on that day. The LEAPS would have been introduced a week earlier on the prior Monday. It is anticipated that the rules put into place this year will become permanent.
You might be wondering why the introduction of the 2011 LEAPS is important. Take a look at my article of December 6, 2007 entitled "Avoiding Disaster with Portfolio Insurance." It explains a method of protecting your portfolio using LEAPS as opposed to shorter term Put options and providing a lower net cost for the protection.
Symbology Initiative Deadline Extended – Earlier this year, the Symbology Committee of the Options Clearing Corporation voted to extend the implementation of the new symbols that will be used in identifying and processing options trades from July 31, 2009 until February 12, 2010. While this change is desperately needed to change the arcane way in which options are currently represented, the committee decided to grant the extension to allow the cost of the development to be spread over an additional year. In addition, several clearing firms complained that the July deadline put too much of a strain on their internal resources and that they would not be in a position to implement the changes by the original date. When the changes finally do take place, most options symbols will match the underlying security symbol and there will be several other benefits to the clearing process.
As I indicated early on, today and tomorrow are likely to be roller coaster days. If you're trading, you probably want to keep your eyes on the market so that you can react quickly to any changes in your positions. It's probably not a good time to put on a trade and go fishing. Be careful.
As always, if you have any questions about my articles, have suggestions for future topics, or want more information about our options mentoring program, feel free to email me at: sfreifeld@tradingacademy.com or call me at: (888) OTA-2580 ext. 2010.
11. Know Thy Options!
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Stan Freifeld comes to us from the Floor of the American Stock Exchange where he traded options for his own account from 1994-2001. He was a Market Maker for the options on several popular equities including Dupont, Schering Plough, Walgreen's, CBS, U.S. Surgical and Biovail.When he is not trading or thinking about trading, Stan relieves his stress by playing competitive squash, competing in local road rallies with his Ferrari Cabriolet and tutoring local high school students for the SAT's. The bottom line is that Stan, a long time MENSA member, is an engaging teacher with an extraordinary background in options trading and risk management. He is helpful and patient by nature and equally at ease with all levels of traders, from complete novices to advanced pros and academics. He'll be happy to teach you to trade!