VIX Hits Highest Level Since Q1 2003

This market can be more than a little disheartening for those who are somewhat new to options side of investing and aren’t used to this recent volatility in the markets.  I took a look at the VIX chart on Yahoo! Finance and saw we are at the highest point since late in the first quarter of 2003.  I knew it had been a while since the VIX was this high, but really didn’t know it had been over four years.

Along with a potential contrarian indication as Schaeffer’s Research says the extreme points can indicate, the VIX means more to options sellers who are trying to make money on time value declining.  The higher the volatility, the higher the premium.  For those who got caught selling during the periods of low volatility and have held on to where we are now the premium might not be showing as much of a decline as you are used to.  The higher VIX is the reason.  In option terms known as “the Greeks” the increase in the Vega (volatility) is evening out the Theta (time value) decline.

If you backed off a few months ago like a lot of us did and sold fewer options than usual, this can be a good time to start selling shorter contracts.  As I typically sell close to two months out, I’m aiming for closer to one month out now and my premiums earned aren’t that much lower.  Of course the risk can be even greater in a volatile market that the underlying stock can fall further and that the VIX can increase more.  Both can cost you.  In the end, VIX does not matter to someone who has sold an option that expires OTM as all the Greeks go out the window at expiration.  Only in-the-money options matters at that point. 

Getting to expiration can be tougher for those who have sold too many naked options without considering the margin requirements that might cause a margin call if the premiums sky rocket.  By no means do I think this is a time when getting in that deep should even be considered.  What I’m considering for a change is to sell more calls.  As of about 10:00 am this morning, all equities in my IRA that weren’t covered now are, aside from CSCO which I only have 100 shares of.  I sold all OTM in the hopes that the stocks recover some, but don’t break through my strikes so I can keep writing more covered calls.

I’m also starting to sell naked calls on some of the positions where I’ve also sold naked puts.  This will be a “Strangle” where I sell both puts and calls at the same month expiration, but different strikes.  My hope in this would be that the stock falls in between both strikes and I “win” on both.  With volatility up, I can capitalize on the shorter contracts required to bring in a higher annualized return.  This morning, with Alcoa (AA) trading at 34.85, I sold two September 40 naked calls (AAIH) and received $138.50 after commissions.  The September 35 puts I sold a couple of weeks ago were the first leg in the strangle. I didn’t have a lot of success with selling naked calls a few years ago when I tried, so I’ll ease my way in and not attempt it on stocks like NYX and CMG that can move $5 in a day.

Schaeffer’s Research offers the following definition of VIX:

CBOE Volatility Index (VIX): The VIX gauges expected market volatility over the next 30 calendar days by calculating a weighted average of the implied volatilities of eight S&P 500 Index (SPX) calls and puts that have an average time to maturity of 30 days. Extreme high and low VIX readings can provide good contrarian signals, though it actually doesn’t matter where the reading lies on an absolute basis if it is at an extreme relative to its recent readings. Buy signals often occur as the VIX reverses lower after an extreme peak, while sell signals occur as the VIX moves higher off an extreme bottom. 

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