Using Options To Gauge Stocks Sentiment
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The options that are listed at exchanges like the CBOE and AMEX are derivative instruments that trade based on equities or equity indexes. They can be used for hedging or speculating on the underlying stock or index they trade off of. Another way options can be used, that some investors and traders may overlook, is to gauge the sentiment of a stock or the market's direction. Here are some methods to do so.
Look For Unusual Options Activity
For example, if we look at unusual activity on The Option Insider, we can see that there was a large trade in Marathon Petroleum Corporation 50/60call spread trade. This could be bullish. What we want to see is a combination of a large amount of volume, which would be the large trade and open interest. If we look at the 50 calls, the open interest is substantial. Marathon Petroleum Corporation (MPC), is also trending towards it's 52 week high. Does this mean that people think it will break through it?
Comparing Implied Volatility With The Historical
Historical volatility is the actual volatility of a stock over time. Usually, the time frame is one year. Implied volatility is the volatility measurement backed out of the price of an option.
Each option strike price has an implied volatility, for puts and calls. Out of the money strikes, tend to have higher implied volatilities than near and in the money ones. This is called the "volatility smile", because if you graph the volatilities over their strikes, it will look like a smile, as the volatilities go up for the out of the money options.
If we look at our Marathon Petroleum Corporation example again, we can see that the historical volatility is 34.52% and that the 50 calls have an implied volatility of 30.2%. Close to where we would expect it to be.
The VIX, Implied Volatility And Complacency
The VIX is a measure of the implied volatility of options on the S&P 500 index. Many traders will use it to get an idea of how complacent the overall stock market is.
As the stock market goes up, the VIX tends to go down. Indicating the stock market is more complacent. The idea is that as the market becomes more and more complacent, it is setting itself up for a big crash. At that point, the VIX will go back up.
Options are more than just a vehicle that can be bought and sold. The way options are trading can tell us what people are thinking about where underlying market will go.
This article was written by Larry Wishnick for on .
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