Opening Position
May 2007
In February 27, 2007, the financial markets saw a sharp selloff triggered mainly by the Chinese financial markets, which dropped 9%. Concerns of geopolitical tensions between the US and Iran as well as the turmoil in the subprime mortgage markets added to this pessimism. Fortunately, the markets recovered most of that loss in a few weeks, and we saw investor sentiment reverse and become more optimistic. There's a strong chance that the Federal Reserve's decision to keep interest rates steady at 5.25%, and the likelihood of cutting rates during the course of the year, had something to do with the recovery.
Selloffs like the one we saw on February 27 can lead to sharp spikes in volatility, typically measured by the Chicago Board Options Exchange's volatility index (VIX). Its value soared 64% after the selloff in Shanghai. After a long -- perhaps too long -- period of historically low volatility, this type of scenario can come as a surprise. But it did add some excitement to a market that had been complacent for far too long.
The price of an option contract is very sensitive to changes in volatility, which is why it is important for option traders to keep an eye on this variable. According to Lee Lowell, the Technical Analysis of STOCKS & COMMODITIES interview subject for the month, volatility can play a large role in your success. But in addition to volatility, there are other variables an option trader needs to be aware of. These include the delta, theta, and time decay, among others. An understanding of these variables will help you understand the different strategies that Lowell discusses in the interview, which starts on page 62. Once you finish reading it, I am sure you'll be reaching for his recently published book.
You can apply multiple strategies to options, and that idea may be overwhelming for someone who hasn't traded options before. With our readers in mind, we have started a series of articles based on a seminar offered by Chicago-based trader Dan Sheridan. The first part of this series, which starts on page 19, discusses calendar spreads. You won't have to weed through a lot of formulas or equations in this article, but for those of you who want to step into the option arena, this article may just be your stepping-stone. Finally, if you have more experience in option trading, you may want to try "Option Arbitrage" by Jesse Chen. The article starts on page 58.
The markets may be returning to a state of complacency, but be prepared
for surprises. After all, that's what adds the fuel to trading.
Jayanthi Gopalakrishnan,
Editor
Originally published in the May 2007 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
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