March has been very kind to the markets.
Share prices are on the rise, as investor appetite for risk has increased.
And volatility has cooled. Thursday, March 24, was the ninth day in a row that the S&P 500 Index closed up or down by less than 1%.
During the 48 trading sessions prior to the start date for this placid streak, it happened 27 times.
So 2016 was on pace to be one of the most volatile stock market years since the 1930s.
This is no time for complacency.
It’s time to learn about volatility and how we can use it to our advantage.
Lee Lowell is an options trader with two and a half decades of experience, including a lot of time making markets on the floor of the New York Mercantile Exchange.
He’s also Wall Street Daily’s Chief Options Analyst.
In today’s Saturday Spotlight, Lee explains how volatility – “the range of moves for a stock or the market in general” – can affect the market.
Lee describes the Chicago Board Options Exchange Volatility Index (VIX), widely referred to as “the VIX.”
The VIX is based on prices of S&P 500 Index options with near-term expirations.
The VIX is currently at 14.74. That’s down from intraday highs above 30 in mid-February and the mid-50s as recently as August 2015.
The “floor” for the VIX is generally understood to be around 10.
During the Global Financial Crisis, in late 2008 and early 2009, it spiked above 95.
The VIX spikes when stocks move lower “because everyone’s clamoring for downside protection.”
As Lee explains, “They’re either selling their stocks or buying put options.” And the VIX spikes when everyone’s trying to get out the door at the same time.
So the market and the VIX have an inverse relationship – when the former goes up, the latter goes down, and vice versa.
That the VIX is below 15 is an indication that stocks are going higher – and that there’s a lot of complacency in the market right now.
And it’s possible that the S&P 500 is “topping out.”
At the same time, you never know when it’s going to turn. And the VIX, as shown in the chart Lee refers to in his presentation, can stay low for long periods of time.
That means the market can keep going higher for long periods of time.
Note as well that spikes in the VIX are very short term in nature.
That means down moves for the market are short term in nature, too.
Anyone who’s been in the market for more than a few years understands that “huge, massive down moves are very quick and very short.”
Stocks go down very quickly… and they rebound very quickly.
The Power to Choose, the Power to Profit
So how does the VIX influence an options trader?
Volatility is one of the components that affects the price of an option.
The others are the price of the underlying stock, the “strike price” of the option on that stock, and the length of time remaining until the option expires.
Lee’s primary focus – in today’s presentation and in his premium service Instant Money Trader – is on put options.
A consummate educator, Lee walks us through an options pricing calculator using Walt Disney Co. (DIS) as his subject.
Disney closed at $97.22 on March 24.
In his demonstration, Lee inputs an out-of-the-money strike price of $65 to create a pricing scenario for an out-of-the-money put option with an expiration date of October 21, 2016.
Now, the gist of Lee’s pricing demonstration is the change in “Volatility %.”
From an initial setting of 38%, Lee adjusts downward to 33%.
That 5% volatility reduction results in a 46% change in the price of the October 21, 2016, $65 put option on Disney – from $0.87 per contract to $0.47.
As an options trader, your goal is to sell options when they’re expensive and buy them when they’re cheap.
If the VIX is high, you’re looking to sell options. And when it’s low, you’re looking to buy them.
That’s how Lee does it – “the smarter way to trade options.”
Lee closes with an illustration of the inverse relationship between the S&P 500 Index and the VIX. When the S&P moves up, the VIX moves down, and when the S&P moves down, the VIX moves up.
Lee’s waiting for a down move in the S&P and a spike in the VIX for an opportunity to sell more put options on high-quality stocks.
Note that Lee took advantage of the options pricing dynamic to book profits on multiple put-sell positions for Instant Money Traders this week.
In an October 6, 2015, piece for Wall Street Daily, Chief Technology Analyst Louis Basenese asked whether Fitbit Inc. (FIT) was “the world’s most dangerous tech stock.”
Now, four months on, we have pretty clear and convincing proof that it is indeed a dangerous investment.
Fitbit is down 60% since Lou wrote that article – which inspired such comments as “Louis Basenese is clueless about Fitbit.”
As Lou notes in his update on the stock, “Being clueless has never felt so good.”
We should all be as “clueless” as Lou. Click here to learn more about how to profit from research by one of the savviest tech analysts in the world.
Senior Analyst Greg Miller has the latest on the saga of another tech outfit with a sad trajectory, as Facebook Inc. (FB) recently announced that it will stop supporting BlackBerry Ltd.’s (BBRY) operating system on its platform.
“For BlackBerry,” Greg writes, “it’s a monumental decline, given that the company essentially invented the precursor to today’s ubiquitous smartphone.”
Once upon a time, BlackBerry soared from below $4 to above $150. Today it’s “a wasteland.”
Chief Income Analyst Alan Gula trains his sharp eye on the energy industry this week to evaluate Exxon Mobil Corp.’s (XOM) balance sheet.
The Super Oil’s net debt has grown from $2 billion in 2012 to $35 billion. As Alan notes, “Exxon’s net debt-to-EBITDA, a measure of leverage, has never been higher.”
The upshot is Exxon is “out of place” among the other two companies with AAA credit ratings – Microsoft Corp. (MSFT) and Johnson & Johnson (JNJ).
Indeed, Standard & Poor’s placed Exxon on negative credit watch on February 2, 2016. And Alan expects its “coveted AAA rating” to be cut.
“Of course, a rating downgrade to AA+, or even AA, won’t be the end of the world for the company,” Alan writes. “Nonetheless, the marginal cost of debt capital does matter for a capital-intensive business.”
Global Markets Analyst Martin Hutchinson is generally a fan of emerging markets.
He has some critical information for income-seekers who might consider emerging-market bonds for their high yields.
“Unfortunately,” Martin concludes, “emerging market debt just isn’t as good a deal as emerging market stocks.”
Martin also provides an update on happenings in Brazil, where “the economy continues to decline, and the budget deficit is spiraling to infinity.”
In light of continuing political turmoil, economic malaise, and social unrest “the only solution is a clean sweep” of Brazilian leadership.