by Dawn Pennington 04/09/08
It's been easy to feel like a prisoner to this market. You buy strong stocks with the hope and maybe even assumption that they will go up on a good day and stay steady, at least, on a bad one. It's been unnerving, to say the least, to watch your favorite stocks open up several points lower because an economic report comes out that the market doesn't agree with. But if you bail out now, what if you miss the upside that has to come eventually?
The Dow (DJI) has gained 870 points in the past four trading days (and lost 293), providing some much-needed relief and restoring some lost confidence among those who trade based on what the market's doing. But just because the market has had a few good days, though, it's really the options traders who can give the best snapshot of where the market is doing now ... and where it's going.
Investor fear, as measured by the Volatility Index (VIX), has looked like a multi-month angina attack splayed across a heart-rate monitor. The markets got St. Paddy-whacked mid-last week as options expiration dawned. The (quad-) witching hour is over (quad-witching refers to the simultaneous expiration of options, index options, stock index futures and single-stock futures, which happens quarterly), and as long as there's uncertainty in the markets, volatility could remain elevated.
This means traders and investors may be embracing the current updraft, but they're still pretty wary of it nonetheless. And as an options trader, you can trade volatility itself by trading VIX options. The VIX closed just below 26 today (consider that to be somewhere between yellow and orange on the Department of Homeland Security's terror-alert advisory system). And if you take a look at its option chain, you'll see that many of your fellow traders are embracing the volatility and figuring out how to profit from it.
Especially in such a news-driven environment (i.e., 400-point market surges when the Fed cuts interest rates, 100% gains in Bear Stearns (BSC) on news that JPMorgan (JPM) will increase its $2-per-share bid to $10), if you've got the stomach to hang in there for the short term, you could make some spectacular profits if you can refrain from hiding your eyes for more than just a few moments (as tempting as that may be sometimes).
The thing is, the markets may rise (and fall, and rise again). But other than the occasional stock blowup, what the market pundits may classify as a "disaster" is really just a pullback or even simply even a bear market.
And we don't say "just a bear market" lightly, but that's all it really is -- the market is down for the count for a few days, weeks, months or even a few years -- but there's no need to count it out. Instead, we simply adjust and learn to appreciate the rallies when we have them but stay prepared (by buying puts) so that we can have winners in our portfolios even on the ugliest market days.
So, keep buying calls to create highly leveraged long positions in the underlying stock, but don't forget to "bear" with your put option positions that might not have fared so well in the past few days and maybe even consider using VIX options as another way to hedge your portfolio. Like the proverbial "they" say, "If you can't beat 'em, join 'em." The market is always going to have some degree of volatility, so instead of feeling powerless to it, realize that there are always profits to be made -- you just have to be creative and downright persistent about going after them.
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