The Return of Volatility: What it Means for You
The recent surge in volatility reflects more investor fear coming back into commodities prices. That can be a good thing for option sellers.
While market volatility can put mainstream investors on edge, it’s a welcome and crucial ingredient to Option Seller’s success
If the markets were a fishing spot, this summer would have been a hot, stagnant pond with nary a movement in sight. At the bottom of the hole, fat, lazy bass sit motionless in an effort to stay out of the scorching afternoon sun. That’s great if you’re fishing for dividend yields or interest payments. Not so much if you rely on motion to fill your daily pouch. You can still generate premium in these environments. But you have to work a little harder. Those bass won’t bite on just anything.
Volatility can turn indifferent option buyers into famished trout willing to bite on just about anything.
If you sell options, you prefer a crisp, cool, fast running stream with hungry trout pouncing on every fly thrown their way. That’s what volatility brings to the table. Volatility means investors are more anxious. That anxiety stems from two core fears: The fear that a future price movement will cause them a loss, or the fear that they will miss an opportunity. Both of these drive the public to buy options.
Fear drives investors to lax judgment. Fear suspends logic and evokes emotional reaction. Fear drives investors to not only buy options, but pay more, sometimes much more for out of the money options.
There was an old racket (probably still in use somewhere today) where the salesman of burglar alarms would actually pay off a few local kids to break into houses in a particular neighborhood. After a few days of police appearances and resident hand wringing, the salesman (in the name of “protecting the public” and with police blessing) would proceed to solicit the neighborhood for new alarm systems (at an inflated price of course).
Inflated fear drives emotional (and often less rational) demand.
Fear suspends logic and evokes emotional reaction. Fear drives investors to not only buy options, but pay more, sometimes much more, for out of the money options.
The same (although more reputable) concept is at work after a flood or fire in certain neighborhood. Homeowners call their agent to insure their coverage is adequate. It’s fertile ground for insurance salesman. The fear created by the recent event drives demand for insurance.
As an option seller, you are in the insurance business. Volatility is simply the market’s way of measuring fear. Fear of a big move, one way or the other. Fear that a trader could suffer a loss, or fear that he could miss “the big move.”
Thus, as an option seller, volatility is good for your business. Volatility means investors are starting to show some of that fear – and exercising it by paying more for deeper out of the money options. They turn from the sluggard bass to the famished trout. To you, that means writing deeper out of the money options (insurance policies) for bigger premiums.
At the time of this writing, volatility in the commodities markets is staging a comeback after drifting through the dog days of summer. This is true across an increasing spectrum of commodities from energy to silver to even normally placid sugar.
The crude oil VIX (OVX) which measures volatility of oil prices currently stands at 44.38 – nearly 50% above it’s lazy day lows of late June.
The gold VIX (GVZ) is up over 23% since June.
While these figures are off the September spike highs, the trend is clearly up for commodities volatility.
Some argue that rising volatility foretells rising prices. But that is not always the case. Fundamentals for many commodities remain longer term bearish (See Crude Rally Opens door to call sellers starting on page 3). This round of volatility may have more to do with people. People with names like Putin, Assad, Ayatollah, and of course, Yellen.
The trend higher in oil price volatility may have more to do with names like Putin and Assad than any underlying fundamentals.
Whatever the reason, whatever the price direction, make no mistake: rising volatility levels are a very good thing for you as an option seller. This is when you make your hay, or to keep our metaphors consistent, catch your biggest fish.
Rejoice! Volatility is coming back to the commodities markets. So tie the flies and wind up your reel. The stream is running cold and the fish are waking up.
Lets go sell them some insurance policies!
To get a complimentary copy of James Cordier and OptionSellers.com’s new guide to option selling, The Option Selling Solution, visit www.OptionSellers.com/Booklet.