NEW YORK -(Dow Jones)- The stock market's "fear gauge" leapt to its highest level in nearly two months Friday. But for some options strategists, it is the wrong time to hide in a bunker.
Traders reached for protective options as they eyed the trio of unrest in Egypt, disappointing bellwether earnings and Nasdaq OMX Group Inc.'s (NDAQ) index glitches. As stocks slid, the Chicago Board Options Exchange Market Volatility Index, or VIX, surged 24% to levels not seen since Dec. 2. The VIX tends to jump when stocks fall. It closed 3.89 higher, up 24%, at 20.04.
Volume in put options swelled across the market.
"You have to take advantage of pullbacks," Oppenheimer & Co. chief options strategist Michael Schwartz said. Options traders should consider selling put options on stocks they find attractive, Schwartz said, which lets traders collect premium income before owning shares they plan to buy anyway. If the shares don't fall past specified levels, traders keep the premium income, and won't be required to buy the stock.
Big block-order put sales crossed in options on glass-container maker Owens-Illinois Inc. (OI) and the Materials Select Sector SPDR (XLB) exchange-traded fund, among others. An anxious day such as Friday is "the perfect opportunity to sell puts, to my mind," Schwartz said.
The natural tendency in an anxious market is to buy those bearish and protective contracts.
"The immediate knee jerk is to [buy] options premium, looking for that pullback, and that's driving volatility," Interactive Brokers senior market analyst Andrew Wilkinson said.
Options traders should generally aim to sell into rising volatility levels rather than buy options when premiums are high, Wilkinson said. One strategy is to sell call options against the purchase of preferred stocks, he said. This is another premium-collection strategy that takes advantage of higher "implied volatility" in options prices.
At the same time, strategists said more risk-averse traders could stand to wait a session or two. "When the market starts falling, it falls under its own weight, and that boosts the VIX even further," Wilkinson said. "If by Tuesday the VIX has gone through 20, people will be more inclined to say that we've had an aberration in this recent period of low volatility, and we're getting back to 'normal'," he explained.
The ratio of bearish S&P 500 puts to bullish calls leaned to puts. Traders picked up 615,000 S&P 500 puts compared with 266,000 calls, data from options analytics firm Trade Alert showed. Over the last month, the S&P 500's put-call ratio has been much lower.
The day's slide in stocks surprised even some in the CBOE's VIX options pit, where traders specialize in market volatility.
"There was a slight feeling of panic with the second down leg of the S&P 500" in the late morning, said Dominic Salvino, a specialist and VIX options market maker at Group One Trading.
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