These past two weeks have seen a sharp increase in volatility and peaked on the “Flash Crash” last Thursday. For many stock traders this can be a tenuous time, but those trading higher probability option trades these times present opportunity. Let’s face it, the realities of an ever increasing market favor the directional trader, and is a great reason to have that as part of a portfolio. However, it is times like these that makes the additions of options a nice hedge to uncertainty.
In Figure 1 you’ll find a chart of the S&P 500 Volatility Index (VIX). As the VIX spiked to a 42 handle there is opportunity to take advantage of the panic. A high probability trade that can capitalize on high implied volatility and will make quick money on a sharp bounce-back are short put verticals. A short put vertical entails selling a higher strike price that is out of the money and buying a strike price that is lower than the one sold. Last Thursday a May 109/107 short put vertical could have been entered on SPY for about $0.40. This trade would have entailed selling the 109 put for May and buying the 107 put. The maximum gain in this trade the $0.40 credit received and the maximum loss would be a $1.60. The max loss is calculated by subtracting the the credit from the difference in the strike prices.
This trade could have been closed for more than 50% of its maximum gain the following Monday following the Euro-zone bailout for Greece. Alternatively, this could be held toward expiration with a likely chance of taking home near maximum gain. This view is very contrarian to the panic that is ensuing and allows one to capitalize while still placing yourself in a likely position of winning even if the market doesn’t make an appreciable turnaround. Taking a short on the crash would have likely resulted in a loss had it been held over the weekend, and a long taken last Thursday may have resulted in a loss with the weakness last Friday triggering an exit or stop.