Two days and counting ...

Posted on February 22nd, 2013

We talk about volatility so often on this site because it is such a key part of the cost of any option and derivative. Our post yesterday was on volatility and so is today's post. We had a second day of a sell off and the VIX increased again - although only a modest half point. The sell off yesterday had conviction. Bargain shoppers late in the day tried to rally the market and made an intra-day high, but the markets stayed in the red all day.

We said in our post yesterday that we have to watch this closely. The VIX in particular is a proxy for what market protection costs in the options market. We want our long term protections to be locked in at the lowest prices we can find. 

Today the market is up a little less than a half a percent - but still below Wednesday's closing price. This will bear watching. The slight market bump today has brought the VIX down slightly - taking back the half point it gained yesterday. 

So, how do you think about this market, the VIX, and buying your Buy and Hedge protection? Here is how you play it:

If you are bullish and think this correction this week is short lived: WAIT and buy your protection later. As the market climbs again, the VIX will likely decline giving you much better entry points for buying your protection. 

If you are bearish and this this correction is the beginning, then make sure your protection is locked in before the VIX goes any higher. In fact, if you have protection in a ladder that is expiring in the next 3 months and is more than 10% out of the money, think about rolling it early like now. Lock in better protection levels at these lows. If the VIX really shoots up, you will be rewarded nicely. 

If you don't have a market hypothesis, then still lock in your protection now in long dated options. But maybe only buy 2/3rds to 3/4th of your protection now. The VIX is still at historically low levels. Buying now should work given the relative discount the VIX is giving you. But a few more days like Wednesday, and that discount will be gone.

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