What Does a Carpet Bomb in SPX and a Lower Trending VIX Mean to You?

The VIX options for February expiration settled yesterday morning at 22.50 based on the calculation of the implied volatility in the S&P 500 options on which this index is based.

This typically causes what is known as the carpet bomb in SPX options on the open, where today, every out of the money March put and call option in with a market will trade.

Take a look at the volume on the OptionsHouse chain.

This settlement procedure can move the index a great amount from the prior nights close if all the carpet bomb orders are on one side of the market; buying or selling. Yesterday, that was not the case, as the final settlement was only pushed slightly higher pinning the 22.50 level. However, the VIX is unique in that it doesn’t really have an underlying that can be easily traded by retail investors. Traders who were long the 22.50 calls saw their premium of 32 cents disappear. So did the holders of the 22.50 puts who saw 25 cents of premium vanish. Please be aware of the special risks associated with trading in these VIX options.

As an indicator of market sentiment, yesterday the VIX was trending lower with the modest rally in the market.

The indicator fell back down to the low 20s late yesterday, possibly reflecting the unknowns of the sovereign debt crisis in Greece, and the passing of earnings season. Also, the fact that yesterday’s rally in US equities basically held steady throughout the day may be lessening fears of option traders. A low-trending VIX so close to Friday’s expiration seems to indicate it may be a quiet one.

Most investors have what is known as positive beta to the overall market. 

Beta is the term in finance that describes the relationship between a portfolio’s return and the market as a whole. This means even the best individual stock picker in the world could lose money if the market has a day like yesterday and today. Over two days losing almost 5% with every sector falling more than 3%.

 What Can You Do When Your Trades Turn Ugly?

I have traded options professionally for more than 25 years, and to me, the one simple key to having a long career is discipline.   

Discipline is paramount for success over the LONG term. Every trader has a limited amount of capital (money) available to trade. The trader without discipline will make trades, be quick take the profit when he is right, and call his trade an investment when he is wrong. 

This action of cutting winners and letting losers run will almost certainly eventually lead to trading capital being wiped out. The natural tendency in humans is to take profits.  Learning to cut losing positions and let winners run is a skill that must be developed. 

 Have you ever caught yourself saying any of the following statements to justify inaction on cutting a losing position?

•  I am holding on to this trade and hoping it recovers 
• If I didn’t own it already I would be buying it here
• I just want to get back to break even and then I will get out
• The market is wrong

Everyone has said these things at some point in their trading lives, but let me tell you, any time your position requires HOPE it is likely HOPELESS!

If you say I would buy it here and you don’t want to buy more – you may be better off selling what you have!

The market doesn’t know or care what price you bought a position. The market price of a stock is the value of that stock right here, right now!  Even though the market presents opportunities, market pricing is not WRONG. 

While I am not giving buy sell or hold advice, I would strongly recommend that when you find yourself staring at a losing position consider selling it! If you  close it out completely,  you can really make an honest determination when you ask yourself, “Do I REALLY want to own it here?” 

Too often I see traders let their existing positions do the talking for them. Don’t fall into that trap!

See the OptionsHouse How-To tutorials on how to use stop order and trailing stops  [VIDEO] to learn the mechanics of cutting losing positions.

Keep your discipline!

Photo Credit: Pandiyan