Buzz and Banter
VIX is scaping along its multi-year lows and there seems to no end in sight based on the market action. Even though VIX is up slightly today, this is due to some put buying in a few of the sub indexes. In individual equity options, I see nothing but option sellers. As the selling continues in individual equity options, it begins to spill over into index option pricing. As I have described, in my mind there are three basic phases to the supply for options that generates an overall decline in market volatility.
The first phase involves over-writers, those investors that are long stock, comfortable with holding it, but selling out of the money options to generate income (a subset of this activity is put selling in lieu of stock buying). Some would say this is hedging activity that as a contrary indicator, means that there is more buying ahead. I have already stated that I look at it differently. Over-writing only hedges the downside for the amount of premium, probably 1-2%; then these participants are just long stock. It also does not foster short covering: when prices rise they either roll their options (although this creates some demand) or just let the stock get called away.
The second phase of option selling involves volatility hedge funds and market makers, who seeing the supply of options and who begin to lose money being long options (volatility), begin to sell out their long gamma. This phase is somewhat like capitulation and leaves the market vulnerable as these leveraged players have no long gamma in place.
The third phase is when the levered hedge funds and market makers sell volatility to open to make money. This leaves the market very levered and was the situation in 1987.
My best guess is that we are at the end of the second phase and beginning the third.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter