Volatility means Time for Option Sellers to Make Hay

By: James Cordier, Michael Gross, OptionSellers.com

Gold and Silver Call Sales look Particularly Overvalued after Equities Market Plunge

Is it me or is anybody else getting tired of hearing another stock analyst tell CNBC what a great “buying opportunity” the latest equities collapse is offering?

It’s nice to be in a business where you don’t always have to be bullish.

When we recommended selling oil and gasoline call options in May, I must admit that we expected prices to experience a fundamentally based, orderly decline into mid-summer. I did not expect the complete price wash-out we got this week as a result of the European/Greece conundrum. That being said, I’ll take it – as I’m sure the many investors out there that sold energy calls will as well.

We’ve discussed the market’s relative “complacency” as reasons for shifting to a covered spread strategy last over the last 6-8 weeks. This week’s price action in the S&P, Crude Oil and Gold are good reasons why covered strategies can be a good idea when markets start projecting that “eerie quiet.”

And finally, equity traders may have another great big reason why diversifying into other asset classes such as commodities can be a good idea. On Thursday, trading “error” or not, Stocks had their biggest one day collapse since 1987. While the indexes partially shaved the loss by the close, it did not erase the sheer panic and fear that gripped investors again (reminiscent of 2008). As televisions across the western hemisphere beamed back video of Greek Protesters throwing Molotov cocktails at police, the market fell almost in tandem as panicked investors large and small called their brokers with the “GMO” order (Get Me Out!). To be fair, a good portion of the “accelerated” selling that occurred during a particularly harsh 10 minute period was due to computer generated selling as stops were triggered on the way down in addition to what some are now calling a trading “error” by a large investment firm.

Meanwhile, in commodities, things were getting interesting as well. But not even close to the magnitude of equities. Gold was up, oil was down – but nowhere near the historic levels seen in stocks. Over in the agricultural trading pits, corn prices meandered up and down a penny or two, seemingly contemplating how much rain Iowa would get tomorrow. Greece didn’t seem to matter.

Orange Juice barely budged. Cocoa was higher on the day.

I say this not to wave the commodities banner but to draw together through live current event- all of the lessons you have been reading and listening through article, email seminar and audio for the past several months. Diversify (Real Diversification – into non equity correlated assets), Don’t be afraid to go short certain markets (by selling calls), and write Covered when things get too quiet.

And of course, today’s lesson which is, get ready to start selling premium when things get loud.

Positioning on Volatility

Many of you may recall Dan Akroyd and Eddie Murphy standing in the Orange Juice trading pit in the 1983 movie Trading Places, as mayhem erupts around them. In the scene, Akroyd instructs Murphy, “Wait….wait…wait……..NOW!!!”

As an option seller, that’s the point at which you should be right now.

When market movements start getting wacky and fear comes back into the market, premium at ridiculous strike prices becomes available. In big moves like Thursday’s, confusion reigns and volatility is injected into all markets. Thus option value inflates – more or less depending on the market.

Dan and Eddie Played it cool when Panic Ensued around them. Aspiring option sellers can learn from their example.

Option values tend to price in (and often way over price) worst case scenarios on the first day of an “event.” Thus, you not only collect much larger premiums, but your risk of those premiums increasing drastically again, are probably less than if you had sold them under normal circumstances. This is true especially if the market has apparently overreacted to a situation. In other words, after an artillery barrage, it’s often a good time to jump over the wall and storm the bunker.

Deep out of the Money

Gold is a good example here. Gold was up nearly $30 per ounce yesterday – an impressive move higher but not historic in nature by any means. You, as an investor, can sell gold calls at the $2,000 strike price today and collect a healthy premium. You couldn’t do that yesterday. Gold closed at $1200 on Thursday. It moved $30 on one of the most volatile market days in the past decade. Your strike is $800 out of the money. We would need over 25 more Thursdays for your strike to go in the money. Events tend to make people and thus markets behave irrationally.

And to paraphrase Ben Graham, “When Mr. Market shows up in a particularly foolish mood, you may take advantage of him.”

Silver had a delayed reaction to the event, saving it’s rally until Friday. Now premium is once again available at the $30 and $35 strike price values.

Many markets, however, saw option values increase even though the underlying contracts barely moved at all. Volatility can increase on outside market movements and/or events.

But this type of volatility (that is not reflecting movement in the underlying) tends not to last. Agricultural prices are business as usual. Call values are holding up in energies, despite the rapid deflation in oil prices. And I still don’t believe gold prices are going anywhere near $2000 an ounce, Greece or no Greece. Premiums are hefty, spreads are wide.

This article is not about what will or will not happen in Europe and/or Greece. There are plenty of talking heads on television that will be glad to give you their predictions. This is about volatility in markets whose fundamentals have not changed drastically in the past 48 hours. It’s about volatility that, if history is any guide, will not last.

I want nothing to do with equities at this point. However, with low hanging fruit now seemingly available above, and possibly even below certain markets (via call and/or put sales), it is, in our opinion, time to go shopping for overvalued premium.

After the surge in metals volatility, we will be working with clients in selling calls in gold and/or silver at strikes 75-100% out of the money as well as adding premium in other markets.

To learn more about investing in a commodities option selling portfolio, be sure to request your Free Option Seller Information Pack at www.OptionSellers.com .

James Cordier is the founder of Liberty Trading Group/OptionSellers.com, an investment firm specializing exclusively in selling commodities options. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television News and CNBC. Michael Gross is an analyst with Liberty Trading Group/OptionSellers.com. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling 2nd Edition (McGraw-Hill 2009) is available at bookstores and online retailers now.

***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.