The Massacre Continues...
It seems like investors are now in all out panic and drawing out of the stock market like a bank run. It seems like nothing the government or Fed say or do can stop the raging herd from heading for the doors, taking the Dow down more than 500 points today.
I remember saying just a couple of weeks ago that the stock market hasn't declined enough to justify the magnitude of this financial crisis. Now, after declining over 30% from its top (Dow Jones 30), it is beginning to make this crisis look like what it really is. The rate of decline is harder and stronger than the last crisis and second only to the 1987 crisis. Panic is all over the news wire and despair are the traders who walked out of the exchange daily.
The Dow continues to march lower faithfully within its short term and primary bear trend, so technical options traders (that's right, the restriction on shorting does not affect the buying and selling of put options at all.) should have no problem making money lately. The hammer signal yesterday did not confirm today, which negates the reversal scenario I mentioned yesterday (which requires confirmation over these few days). Market direction continues to be down even though I maintain my stand that the bottom may be near and shrewd investors should already be making calculations and putting together a portfolio of good opportunities. Indeed, from the way the total put call ratio declined from the high of 1.51 yesterday to almost on par at 1.1 today, we can tell that options traders are already taking positions in call options, expecting a bottom. Most of these positions are out of the money call options on LEAPS options, expecting the stock market to go higher next year.
I remember saying just a couple of weeks ago that the stock market hasn't declined enough to justify the magnitude of this financial crisis. Now, after declining over 30% from its top (Dow Jones 30), it is beginning to make this crisis look like what it really is. The rate of decline is harder and stronger than the last crisis and second only to the 1987 crisis. Panic is all over the news wire and despair are the traders who walked out of the exchange daily.
The Dow continues to march lower faithfully within its short term and primary bear trend, so technical options traders (that's right, the restriction on shorting does not affect the buying and selling of put options at all.) should have no problem making money lately. The hammer signal yesterday did not confirm today, which negates the reversal scenario I mentioned yesterday (which requires confirmation over these few days). Market direction continues to be down even though I maintain my stand that the bottom may be near and shrewd investors should already be making calculations and putting together a portfolio of good opportunities. Indeed, from the way the total put call ratio declined from the high of 1.51 yesterday to almost on par at 1.1 today, we can tell that options traders are already taking positions in call options, expecting a bottom. Most of these positions are out of the money call options on LEAPS options, expecting the stock market to go higher next year.
Labels: 2008 crash, fundamental analysis, technical analysis
posted by Jason Ng at 6:15 PM
4 Comments:
Hi Jason,
Why would bullish option traders purchase out of the money calls instead of deep in the money when the latter has a much higher delta?
Is it due to cost and ultimately no. of contracts they will end up owning?
OTM options are a great way to make a big bet with very little money.
If price goes up to the level they have predicted it to, they could make a much bigger profit than if they had bought ITM options with more money. In this market condition, no institutional investors would dare commit too much money and would instead use a negligible amount of money for a bet that could produce big returns until market conditions become more certain. In times of uncertainty, using money that one can afford to lose on OTM options is a great way to get involved without getting hit too hard if things don't work out.
Read my tutorial on Out Of The Money Options for all the ins and outs of OTM options.
Hi Jason,
Thank you for your prompt reply. But if most institutional investors are betting via OTM options, that would bring up the implied volatility in them right?
So even if a desired and predicted movement does happen in the underlying, gains may still be wiped out due to decrease in IV when position is closed right?
What's your take on the level of implied volatility you think can be tolerated?
So does that mean that NTM options will be a much better bet than deep OTM options?
Yes, you are right that the more buyers interested in an option, the higher the extrinsic value goes. So there is no such thing as a sure win formula. Investors in OTM Calls right now must weigh the probability and magnitude of their expectations against the cost of the trade and invest if it makes sense to them. For some, it makes perfect sense, for others, it makes no sense. The difference lies in a difference in the magnitude and probability of expectation.
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