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Two Ways to Own Volatility: Which Is Right for You?


You can even get earnings thrown in for free.


It's tempting to own options now.

Volatility is as low as anyone remembers (providing you can't recall anything since last September), and is now relatively close to realized volatility. You can even get earnings thrown in for "free," as in Apple (AAPL).

In addition, I show August as a decent cycle to own over time, although that's partly because it's a time of year where we've seen some outlier events (in other words, the "median" August isn't particularly volatile).

There are 2 basic ways to own volatility: One is to own actual options in an actual stock or index -- like SPY puts, or Google (GOOG) calls. Options in these 2, and pretty much everything else, trade at as cheap a volatility as we've seen in at least 10 months. In the case of Google, they were last here in the fall of 2007.

But cheap doesn't always mean a buy. At the end of the day, you'll need realized volatility in Google (or anything) between now and expiration to exceed the implied volatility you paid for the option. In other words, you could catch the absolute low tick in Google options volatility and still lose money if Google volatility itself remains lower. You won't necessarily lose money if it was a good directional bet and you rode it well (e.g., bought Google calls and never hedged and the stock inched high enough). But in theory you then made a bad allocation decision as you should have just bought and held stock instead. So even if profitable, it was not a "good" buy.

And never forget real options carry real time decay. So every day you buy before actual stock volatility picks up may cost you money.

The other way to own volatility is to make a pure bet on it via a VIX product. But again, not so simple. August maintains a premium as we noted, so even though you see a 24 volatility on the screen, you can't actually "buy" the VIX there. You have to pay more like 28+. You can buy VXX, an ETN that tracks a theoretical 30-day rolling VIX future, but again, it presumes that August future price and won't rally as much as you think if, in fact, the VIX lifts.

Bottom line, options have gotten cheap enough to where net selling them looks very risky, as you have little cushion for a sudden move. But by the same token, it doesn't mean you go back up the truck and cross your fingers that volatility starts ticking up I'm personally looking more for volatility-neutral plays like vertical spreads and calendars. I'd rather pay the equivalent of 30 VIX in an options uptrend than 25 VIX and hope for the best.

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No positions in stocks mentioned.
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