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VIDEOMarket Commentators All Wrong on Options?
It's essential to challenge these mistaken assumptions.
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Can’t take it anymore. I’ve seen this too many times to not comment. Yesterday, a reporter for the Washington Post’s “The Ticker” wrote: “At least one trader today placed a nearly $1 million bet that the VIX will rise above 45 by July, buying several thousand option calls.”
No, no, a thousand times, no.
Just because somebody bought a million dollars worth of options does not mean that that person thinks volatility is going to 45. People buy options for 2 reasons: speculation and hedging. There's simply no way to know from the information presented in the article whether this VIX call buyer was a hedger or a speculator. If the person was a hedger, then by definition they think the most likely event is that volatility is not going to go to 45, but they want to be protected in case it does. They bought volatility insurance!
The author of this Bloomberg article makes the same mistake. In late May, with crude at 62.26 (see USO for more on this), somebody bought a huge number of July 50 and 40 strike put options. Bloomberg writes: “The number of options to sell oil at $50 a barrel for July settlement rose 22% last week to 24,948. Traders expect prices to fall because US crude inventories are 1.8% below the highest level in 2 decades.”
Does that mean the put buyer thought crude was going down? Maybe. Maybe not. If the buyer was a speculator, then it was a bet on a decline. But if it was a hedger, then it could easily be a producer who simply wanted some price protection.Let me ask you this question: When you own a house, do you wait till your insurance agent can see the flames coming out the window to buy homeowner’s insurance? Do you wait till you’ve lost control of the car to buy auto insurance? Do you wait till you’re dead to buy life insurance?
Of course not. You buy insurance before the fire begins, before the wreck, before you’re dead. That doesn’t mean you expect the house to catch fire, or to have a wreck and die the next day, week, or month. It’s protection put in place before a catastrophic event, just in case.
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