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Hold On Tight: More Volatility Ahead

June 15, 2007

"Buy the ticket, take the ride." -- Hunter S. Thompson

Dear Fellow Options Trader,

First things first, folks: The volatility we spoke of last week stayed in the headlines this week. On June 6, the Dow lost 130 points, and it was pretty ugly. But the next day's 199-point sell-off was coyote ugly. You know -- so ugly you'd chew your leg off to get loose!

That activity inspired many investors to sell everything they could to try to get away from their losses. But was their quick reaction a little too hasty?

THE MARKET SAYS 'GOTCHA!'

Just after the market had almost cleaned out the last of the bulls, on June 8, it turned 158 points to the upside, completely frustrating everyone.

That's how it is in the stock market, ladies and gents. The bears pressed a small advantage, and whack -- their window of opportunity looks like it was a small one! But as I have said here many times, traders and investors have short memories, and although the market was flat as a board on Monday, the Dow fell 129 points on Tuesday, bringing our old friend volatility back from the dead!

Here's a graph of what the Chicago Board Options Exchange Volatility Index (VIX) looked like during the past 10 days:



As you examine the graph, it looks an awful lot like a heartbeat, doesn't it? We're talking about a 23% move from June 6 to June 7 and then a subsequent sell-off back to nearly where it came from! Trading in the VIX call options, which move up in value as the VIX moves up, has also been pretty spectacular.

On June 6, more than 83,225 VIX calls changed hands. That was followed by 140,010 calls on June 8, and then 107,000 calls on June 12. VIX options are a terrific way to gauge expected short-term activity in the markets because a higher VIX reading reflects growing uncertainty in the broader markets. In fact, perhaps it may even be fair to say that the real certainty in the markets is what's being exhibited in the options pits!

CAUTION: SHARP CURVES AHEAD

It goes without saying, but big moves in the market coincide with big moves in volatility. This week's action confirms that we're going to see a lot more 100-point-up and 100-point-down days in the short term.

And with the Dow closing up another 85-plus points today, this goes to show that some of our positions that have slid have a very good chance to ride up. Only you know what's best for your portfolio and your risk tolerance, but we've seen slight recoveries in some of our positions in the past few days, and there may be more where that came from.

It's sometimes hard to stay bullish when our fellow traders and investors start hitting the exits at lightning speed, oftentimes taking the value of our positions down with them as sellers start outweighing buyers. And market corrections, however brief, give us an opportunity to pause and reflect on why our long positions are taking a hit, if they are.

As far as I'm concerned, we have some strong positions on the table, and they survived the recent market turbulence for a reason. And the other positions should catch up in time; if not, we will evaluate whether it's worth it to sit tight or to call it a day and redirect our capital into more-promising opportunities. Let's not forget that options trading gives us, well, options!

OPEN POSITIONS UPDATE

Our Nasdaq Stock Market (NDAQ) June 32.50 Calls (NQDFZ) recently went through their sell stop, so we moved them over to our Closed Positions page. If you weren't taken out of the position already by the sell stop, they came off the board today.

These options traded fast and furiously in April as the Nasdaq was in talks to buy the Philadelphia Stock Exchange, but it wasn't enough to keep these calls profitable. We were able to capture a quick 33% gain on the first half of our position, so this speaks to our discipline of preserving profits while we're up and letting the rest ride in anticipation of more potential upside. In this case, however, the Eurex's takeover bid for International Securities Exchange stole its thunder, and our position didn't reach its full potential.

By exhibiting discipline and treating your option trades as two separate positions, as we often do, we reduce our risk and thus our exposure in the markets in the event that even the most-promising opportunities don't end up going our way.

The good news is that all we have to do is wait a few days for the next swelling of behind-the-scenes institutional money flow to start splashing across the HeatSeeker, and we'll jump aboard that wave and ride it as far as it will take us. While we couldn't do the "Cha-Ching!" dance with NDAQ, we've got a lot more victory dances in store, and by preserving our profits and limiting our losses, we'll still be in the game long enough to see those better days ahead!


Jon "Doctor J" Najarian
Editor
ChangeWave Options Trader