In case you haven't noticed, the market sure has gotten volatile lately. In a little over a week, the Dow has dropped over 400 on a close, traded below 12,000 for the first time in 2007, and rebounded up 150 another day. With so much news to digest, it provides an opportunity for speculative investments as "gamblers" bet on market direction. These types of trades are not for beginners as the market can be especially chaotic during volatile times.
Predicting the stock market's direction takes time and skill but when times are volatile there are some option traders who buy near term options with strike prices close to the market index they are following.
For instance, I like to track the S&P 500 which is an index containing 500 of the biggest companies in the United States. All of the stocks in the index are large publicly held companies and trade on the Dow and the Nasdaq. On Wall Street, it is the most widely watched index of large-cap stocks. The S&P 500 closed on Wednesday at 1392 after hitting a 52-week high of 1461 just two weeks ago. The last week of February was the worst for the market in four years. The Dow and the S&P 500 were down 4%. The
Nasdaq was hit the hardest losing nearly 6%. Yikes!
I bring these figures to your attention because option traders who are nimble will buy calls and puts or a combination of both in hopes of making a profit based on the market's emotion. Volatility will most likely increase over the next few months as first quarter earnings start to roll in and with the debate over the housing sector really starting to heat up.
Another event set to occur is "Triple Witching". This is when the contracts for stock index futures, stock index options, and stock options all expire on the same date. Triple witching happens four times a year and occurs on the third Friday of March, June, September and December. It is an event dubbed as "freaky Friday" on Wall Street.
The scene can be compared to something you would see in the movie "Trading Places" as the chaos is played out by traders in the expiring contracts who try to close their positions before the close. It can have a huge impact on the market as their actions may push the market up or down substantially.
Like I mentioned, some traders may try to profit from this increased volatility, but it�s really difficult to know whether the action will push the market up or down. It's kinda like going to a craps table in Vegas for the first time and if you don't know how to play, it can have devastating consequences.
As the saying goes, big rewards come with big risks. With the S&P 500 around 1390, the March 1390 calls (SXYCR, $14) and the March 1390 puts (SXYOR, $11.70) can easily experience 20%-25% swings during the trading day. No one really knows where the S&P 500 will close next Friday when these options expire but you can bet there will be a gambler out there that believes they do.
