We all worry about the possibility of a large catastrophe at one time or another. When we see the devastation of Hurricane Katrina, Tsunami’s, terrorist plots or recent mining disasters we reflect on what we would do in such a situation. Is there some way you can insure your personal stock portfolio from such catastrophes?
This last weekend terrorists attempted an attack on the giant Abquaiq oil facility in Saudi Arabia. Crude oil jumped $2.37 to $62.91 as a result. Imagine if they had succeeded in the attack…it would have had large implications throughout the world and financial markets would have been in a panic. How do you protect yourself from such an event?
There are many investments available in the financial markets to protect yourself from such events. As an example, one could use stock option investing to insure their portfolio in the event of a sudden spike in the markets. One way to help insure a portfolio is to take advantage of the VIX, or CBOE Volatility Index, options. This index is based on the volatility that is found the S&P 500 Index options and has some very favorable characteristics for catastrophic insurance in the financial markets.
The Volatility Index, which was introduced in 1993, is considered a major barometer of investor sentiment and market volatility. The VIX Index measures the market’s expectations of the 30-day S&P 500 volatility implicit in the prices of near-term S&P 500 index options. The introduction of CBOE VIX options last Friday provides investors a very powerful and flexible stock trading risk management tool.
The VIX indicator generally has a negative correlation to the stock market. When a catastrophic event occurs and the market declines sharply, the VIX will generally go up sharply. As an example is the S&P 500 index were to have a sharp drop of 4% the VIX might rise by 17%. So the VIX not only moves in the opposite direction, but is also more volatile. This uneven ratio between the VIX and the market can yield high profits and good insurance for investors who utilize the VIX options to protect their personal stock portfolios.
The VIX is more sensitive to downward moves in the market than upward moves. In fact, the VIX is near a multi-year low and drifting lower after its sharp rise during the early 2000 investment market declines. In summary:
* Selling naked calls on the VIX appears dangerous and risky.
* Buying calls could be a good market hedge, but they may be expensive if nothing happens.
* Buying puts is not very attractive with the index at a multi-year low.
* Selling naked puts could be very attractive.
Some observations after only a day worth of volume in the new options…
As of Friday, it seemed that writing the 10 strike put option would be a no brainer. But then I noticed no one wrote the 10 puts on the first trading day. Instead, most investors were writing the 12.5 puts, which were in the money (ITM) with much higher premium. It looked like speculators were anticipating that some event could occur in the next few months, which would drive the index up rendering these puts out of the money. If such a move did occur, the returns for these ITM options would be huge compared to the OTM 10’s I originally considered. Both April and May had large volumes in the 12.5 strike puts. It should be noted, the VIX options are European style expiration, with no risk of being assigned prior to expiration.
Options investors can use stock option trading and the patented tools on PowerOptions to research, analyze and compare the VIX options to determine the best possible trade for insuring their portfolios. Investor’s can view the implied volatility, covered call options, and downside protection using the PowerOptions Option Chain.