While the bulls were booing and jeering the market’s downturn, a few groups of market participants were rather enjoying the recent turn of events.
Short-sellers are an obvious winner this week, finally receiving their day in the sun after being denied profits virtually every day of 2013. Theirs has been a hard lot in life of late, but they finally received a bona fide pullback. Time will tell whether they continue to see good fortune.
Aside from short-sellers, another group of traders that should be reveling in the return of volatility is option sellers. I count myself among their membership. Before the Wednesday-Thursday swoon, implied volatility was in the basement not just in stocks, but also in oil, gold and others. While the CBOE Volatility Index (CBOE:VIX) was plumbing new multiyear lows at 12%, the CBOE Oil VIX (CBOE:OVX) had moved below 20% for the first time ever. Not to be outdone, the CBOE Gold VIX (CBOE:GVZ) joined the low-volatility ebb, meandering around all-time lows in the 12%-14% range.
As a result of the continued slide in these VIX indices, option premiums have shrunk, making it increasingly difficult to receive adequate premium when selling options. During such a low-volatility regime, option sellers must (out of necessity) sell options that are much closer to the money if they want to receive the amount of credit they’re used to. The problem with moving closer to the money, of course, is it reduces the probability of profit in the trade.
With the VIX Index soaring as much as 31% this week, option premiums have been re-inflated to a certain extent. Traders looking to sell options on the SPDR S&P 500 ETF (NYSE:SPY) will now receive a higher credit than they otherwise would have had they entered prior to the recent volatility surge.
Click to Enlarge As an avid put seller on the United States Oil Fund (NYSE:USO), I consider the pop in the Oil VIX a particularly welcome development. The amount of premium in out-of-the-money puts is quite a bit higher than it was earlier in the week.
If you want to take advantage of the uptick in implied volatility and believe the downside in oil will be somewhat muted over the coming month, you could sell the April 31 put for 50 cents or better. The max reward is limited to the initial 50 cents received and will be captured if USO remains above $31 by April expiration. If implied volatility drops back down a decent amount and USO rebounds, you might be able to buy back the put with the majority of your profit in a few weeks.
To control the risk in the position, consider buying back the put if USO falls below $31.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.