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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