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Why Now's the Time to Sell Options


They're likely to overprice risk going forward, as they have over most of the past eight months.


In the charts below we have 30-Day IV in yellow for SPY over the past three months, while under that we see 10-Day HV.

IV is the market estimate for volatility over the next 30 days. Some is anticipation, but the lion's share (about three-fourths) is based merely off realized volatility in the underlying. 10-Day HV is noisy, but a good proxy for how the market feels right now.

Here's what's interesting: SPY 30-day options traded at about a four to six point premium to 10-day HV for much of the last two months before the "crash" of late January 2010. And the options response to the "crash"? Almost the same exact bid-up to realized volatility.

Options volatility is never perfect; it's a market estimate. It moves in response to events on the ground. In this particular case, it moved almost in perfect lockstep. In other words, if you found options fair a month ago, you should probably find them fair now. Of course the absolute levels are higher, so there's greater likelihood options volatility dips from here than there was dipping from the levels of two weeks ago.

If you believe options overprice risk going forward, as they basically have for all but a couple blips of the past eight months or so, then not a bad time to make some sales. Stephen Sears has someone with just that opinion in Barron's Striking Price:

The feeling among very sophisticated traders is that investors are too gloomy, and past experience shows that when that happens, it's often a good time to buy. Remember March 2009 when the stock market bottomed amidst epic fear? The Standard & Poor's 500 Index surged forward and gained almost 70% in 2009.

Contrarians often trade these paroxysms because scared investors tend to overreact and sell all of their stocks, driving stock prices lower. In the absence of selling, stock prices snap back.

"Even a blind man -- with a stick, of course -- could see that selling puts now is the trade," one New York-based options trader said.

For more on options, including email alerts with specific trades, strategy and access to veteran options trader Steve Smith's portfolio, take a FREE 14 day trial to OptionSmith.

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No positions in stocks mentioned.
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