Week of April 19, 2010
Unless you were in a cave since Friday, you must have heard about the big news about Goldman Sach’s problems with the SEC involving their sale of collateralized debt options (CDO) allegedly designed by one customer to fail and then sold by Goldman to other unsuspecting customers….allegedly. All I know is that lawyers are going to get rich and that CST’s options director, Dan Keegan has a way to trade that news.
The biggest quandary an options volatility trader faces is when to jump on board the volatility bandwagon. On April 12th the VIX (CBOE Volatility Index) hit its 52 week low by trading at 15.23 and closing at 15.58 that day. On April 15th the VIX closed at 15.89. On the morning of Friday April 16th, expiration day for April options, the SEC announced a civil action against Goldman Sachs (NYSE: GS). The news sent the market reeling and the VIX climbing. Not only did Goldman’s shares lose 13% of their value, but other financials also fell sharply led by Deutsche Bank (NYSE: DB) which lost 10% as traders feared they might be next.
As the market fell, the VIX traded as high as 19.70 before finishing the day at 18.36. The volatility trader can say that this is a mere blip on the radar screen and sell premium into the rising volatility, or look at this as a sea change and buy some premium. Take a look at the options pricing for Goldman Sachs. GS dropped nearly 30 points at its nadir last Friday. The May 160 Puts shot up in value fifteen fold to close the day at 8.50.
Selling the GSJan 2012 150 Puts at 16.20 would be one way to sell into the volatility surge. The current implied volatility for those puts stands at 38.0. If GS stabilizes and starts an orderly climb up, those expensive out-of-the money options will surely melt. To hedge against the short puts the trader can either short stock or buy puts that are closer to expiration. The implied volatility for the nearer term options will be higher but their actual dollar amount is lower. That means that an overall decline in GS volatility will result in a profitable trade
To really get the most from Dan’s expertise, take our options course and maybe you will be able to figure out whether to jump on that bandwagon or not.
