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Dear Friend,
Last week was a bad one for the market. Friday’s 2.5% drop was the worst day in all of 2012. Many Terry’s Tips subscribers did just fine because of our 10K Bear portfolio which gained 23.4% for the week. Over the past five weeks while the market has fallen 8.7%, this bearish options portfolio has gained a whopping 135%. Once again, options offer opportunities that conventional investments just can’t deliver.
Today I would like to talk about an important options measure called VIX.
Terry
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| Option Tip of the Week |
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Option Prices and VIX:
VIX is a measure of the average Implied Volatility of SPY, the tracking stock of the S&P 500. It is often referred to as the “fear index.” When investors get scared, they often buy put options and/or sell call options to protect themselves against a big market drop. When this happens, VIX (and option prices in general) usually moves higher.
VIX almost always moves in the opposite direction of the market. If the market moves higher, VIX usually moves lower, and vice versa.
On Friday, VIX closed at 26.66, driven higher by the big drop in stock values. VIX is essentially the percentage change that the market is expected to fluctuate in a year. The mean average of VIX is about 20, far less than it is today. Quite often, when there is a sideways market with little volatility, VIX hangs out as low as 16.
Today’s high VIX number means that option prices are high. It is the perfect situation for our strategy of selling short-term premium. We love a high VIX.
When VIX moves higher, not only is it possible to collect more premium decay each week or month, but the entire portfolio made up of calendar spreads is likely to move higher as well. This occurs because the long side of our calendar spreads (the options with more remaining life and therefore the ones with a higher absolute value) increase in value by more than the short-term options that we are short.
If an option trading at $6.00 goes up 10%, the option will be worth $.60 more, while a short option covered by that longer-term $6.00 option might be trading at $.90, and it might only go up by $.09. If you had 10 of those spreads in place, your portfolio would increase in value by $510 just because of the higher option prices that result when VIX moves higher.
Trading options is far more complicated than most investments. If you are just buying stock or mutual funds, you don’t even have to know about VIX. But we believe that there is a big payoff for making a little effort to learn about the extraordinary possible returns that an options portfolio can deliver if it is properly constructed.
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Any questions? I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.
You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips and learn all about the wonderful world of options by subscribing here. Why wait any longer to make this important investment in yourself?
I look forward to having you on board, and to prospering with you.
Terry
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| Andy's Market Report |
Last week I went over the following:
‘"You are looking at 1,277 on the downside. The market will test it, but when it gets there it is going to hold because there is a lot of money on the sideline that needs to be put to work," said Ken Polcari, managing director at ICAP Equities in New York.
"People are using that number as the entry point, so you will find stability at that level."
I love when money managers or analysts try to predict the future, as if they know for certain how the market is going to react at certain levels.
If the 200-day breaks in the weeks ahead we could be in for a long summer. We have already seen the “sell in May” effect reach historic proportions during the first few weeks of existence this year, but the slide could become significantly worse if the 200-day is broken. Watch this area closely!
Just when Wall Street thought the market was going to bounce, the unemployment numbers came out Friday to spoil the party.
The bears strength was strong enough to push the S&P 500 below the 200-day moving average without much of a stand from the bulls. Friday saw the S&P 500 lose -2.5%.
According to Jason Goepfert of Sentimentrader.com , this isn't the first time the S&P 500 has seen this type of price action. “Something very similar happened in 2010 and again in 2011. Both led to many months of whippy market action, though the latter suffered a much larger initial shock first.
Those who are bearish on the market will probably seize on the fact that we also saw this right before the market crashes in 1929 and 1987. During the next two weeks, the S&P shed an additional -20% after those occurrences”.
However, since 1950, there have been 12 other times where the 200-day moving average has been violated with a large one day loss. Over the next three months, the S&P was back in positive territory 10 of those times.
Losing support always raises the risk of quick panic selling. But historically this type of weakness turns any short-term weakness into longer-term gains.
Although this time could be different...Europe is still in a quagmire of uncertainty, U.S. growth is slowing tremendously as seen in the GDP this past week and unexpectedly low unemployment numbers. Emerging markets have come to a standstill as well. The global economy is teetering.
On a short-term basis, I would expect to see a bounce off of the current oversold levels, but again, I would watch the 200-day moving average very closely to see how the S&P reacts around that level.
If it now acts as strong overhead resistance we could be in for a long summer.
However, the one positive is that if you are a seller of volatility now is a great time to take advantage regardless of your market direction. Heightened volatility levels increase options premium which favors premium selling options strategies. Try to take what the market offers you at every turn because around each bend is the possibility of a completely different scenario. |
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| Overbought/Sold Condition Report |
Overbought/Oversold as of June 1, 2012
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S&P 500 (SPY) – 24.2 (oversold)
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Dow Jones (DIA) – 21.2 (oversold)
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Russell 2000 (IWM) – 23.6 (oversold)
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NASDAQ 100 (QQQ) – 19.9 (very oversold)
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| Testimonial of the Week |
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I would like to express my satisfaction with your portfolios. My performance far surpasses anything I've ever done in stocks, mutual funds and (don't remind me), investment real estate. I'm definitely planning to increase my capital allocation. I also thank you for your recommendation of thinkorswim. They are a first rate outfit. -- Brad
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Thank you again for being a part of the Terry's Tips newsletter. If you are interested in signing up as an Insider, visit Terry's Tips today for details.
Sincerely,
Dr. Terry Allen
Terry's Tips
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