To some options trading investors, volatility is viewed as an evil force bent on wreaking havoc in the financial markets. To others, volatility is seen as a rare gift from the unmerciful Trading Gods providing additional opportunities. Increased market volatility inevitably leads to a flurry of activity in the options market. Some flee to options in pursuit of protection. Others seek to speculate and profit on a continuation of market volatility or a return to normalcy. Regardless of their motives, this rushing into options can drive option premiums considerably higher. To some, these high prices spell opportunity.
Take the current surge in oil for example. The $20 rally in crude over the past two weeks has countless Americans cursing Gaddafi at gas stations around the country. Another byproduct of rising oil prices is increased demand for options on the United States Oil Fund (NYSE: USO). The primary metric used to measure the supply-demand status for an option is implied volatility (IV).
The USO has its own volatility index known as the CBOE Crude Oil Volatility Index (CBOE: OVX) that has become known as the “Oil VIX”. Recent events in black gold have caused the OVX to rise to levels not seen since last year’s flash crash. Its range in the last 52 weeks has been from $25.01 to $49.88. (See chart below). To put this into perspective, a similar increase in volatility on the S&P 500 Index Options (CBOE: SPX) would take the CBOE Volatility Index (CBOE: VIX) north of 40. In fact, VIX was around 20 in midday trading today.
The elevated volatility in USO options is juicing up the potential returns for many short volatility strategies. One beneficiary is the covered call trader. In a normal environment, selling short term, at-the-money call options on the USO yields about a 3% return. Currently, with USO around $42 and change, traders long USO should consider selling the USO April 42 Call option, which offers a return of 5% to 6%. Those with a more bullish bias on oil could consider selling further out-of-the-money calls such as the USO April 43 Call or USO April 44 Call options.
CBOE Crude Oil Volatility Index (CBOE: OVX)
At the time of this writing Tyler Craig had a short volatility position on the USO.
Follow Tyler Craig on Twitter@TylersTrading.
