VIX and VXN Making a Run

It’s been a few months since I wrote about the VIX hitting four year highs.  On Friday, the CBOE NASDAQ Volatility Index (VXN) closed at 32.52, its highest point since Q3 2003.  The VIX is trying to get back there to its recent highs too and if we get another 100+ point drop in a day it should reach a new near-term high again.  The VXN is surging this time more than the VIX due to the rough week for tech stocks.

If you were a reader here when I last wrote about these volatility indexes you know that they matter, expecially to options investors.  With volatilty (“Vega” when using the Greek terminology) up again, investors who buy calls and puts should be careful.  Once volatility drops again, the implied volatility of most options tend to follow.  That means the vega of the pricing model for options has a smaller multiple and the option is worth less.  This creates a good time to sell naked puts and calls.  Once volatility drops, so goes the option price and the paper profits soar.  The trick of course is that stocks could continue to fall and you could be assigned a stock that can’t find footing.

I didn’t time this pull back as nicely as I did the August one.  I’m already invested more than two times the underlying value of the options I’m short with five days remaining before November expiration.  I’m hoping/expecting a slight bounce this week to get me through it with at least a small profit still intact.  If not, I will have to consider accepting November as a month for losses and move on more carefully.  My trading model assumes I’ll have two to three down months per year and I haven’t had one in a while so I’m due.  The plan is to let the good months outweigh the bad months by a much better margin. 

Even if I had more cash available right now, I’d have to really consider the risks of getting in any deeper until we can see some more solid ground to stand on.  As soon as there is a glimmer of hope showing up, selling put options will be the best game in town, before volatility drops again.  Once volatility drops, buying calls would normally be a good move to ride the markets back up, but this time around I don’t think we’ll have a massive percentage move to new highs as quickly.  That leaves us with my favorite trade, selling naked puts.