The VIX –CBOE SPX Volatility Index is getting a lot of press talking about how low it is registering, hovering near the 12 percent mark (12.28). Looking at a 5+ year chart it is hard to argue the point. Viewing the chart going back to late 2008 — the spike above 80 and the two spikes above 40 since then — the financial crisis tells us that this measure of volatility and fear in the markets may be artificially telling a story of complacency.
However, the actual price movement we have observed in the early days of 2014 of the SPX index is something else. Since the “Happy New Year” high of 1848.36 finishing off a spectacular performance in the US markets in 2013, the SPX index has been much more choppy. On Monday of this week we experienced a drop not seen in the indexes since early November. And just as suddenly today, we bounce back — recovering practically all of the declines from Monday. Neither day had clear reasons for the excess bearish nor bullish behavior. You can try to point to a lack of liquidity, however stock and option volumes are up from the quiet holiday levels as buyers seemed to chase today.
The 10-day historical vol measurement of the index has jumped from a lethargic reading below 7, as of the close on Friday, to 11.41, today. Volatility is movement, either down or up. These last two trading days are injecting a touch of actual volatility to the trading environment which we have not really seen for a while.
So how do you react to this market dynamic change? As a trader you don’t get to pick the market environment but, rather, you have to adapt to the type of market you are trading in. This is certainly not a buy and hold market. Take for example, a 525-535 debit call spread in CMG which most believed was going to expire this Friday safely with both legs in the money in its maximum profit range. Yesterday, however, Chipotle fell from “safely” above 540 to below 530. Holders of that debit call spread should have closed that vertical spread and moved on. I just hosted a webinar last week talking about eliminating bad trading behaviors in 2014; one of them being about trying to make the last penny on positions. Reviewing that webinar again will remind us all to close down teeny risk! As a general rule, it is prudent to begin to think about closing positions when they have achieved 70% of my maximum profits. Further, conventional wisdom strongly suggests you close them down when you achieved 85%. You can think you are leaving free money on the table but that free money can end up costing plenty. At best it only ties up buying power — at worst the short option comes back to life.
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