Option Volatilty Near YTD Lows

Posted by Bull Bear Trader | 4/12/2008 07:27:00 AM | , , | 0 comments »

Implied volatility has recently decreased on the S&P 500 Index options. As mentioned in Barron's: "This follows the Federal Reserve's decision to finance investment banks, seen by many investors as the equivalent of a massive put option that reduces the future possibility of extremely low stock prices." Many options investors are going cash. The low volatility reduces the premium for selling options, while the recent actions in the market (poor news and little upside, Fed propping up various industries) currently makes both long call and long put options suspect, even with lower prices.

What could cause a change? Many believe either continued poor earnings season, or a drop in consumer spending. In a recent post we discussed the lower returns generated during earning season over the last 5-6 years. Credit Suisse recommends that to hedge against poor corporate earnings, investors should take out a bear spread, buying S&P 500 SPY May 135 puts, while selling May 125 puts. Goldman Sachs gives a similar position bias, but recommends hedging with SPY puts that are 5% out of the money. As mentioned in Barron's, "Those are both good ideas, as GE's earnings shortfall may signal more bad news and rising options volatility."

Tickers: SPY