Dan Keegan, options instructor for The Chicago School of Trading, talks about his options strategy in the current low volatility environment.

We’re at The World MoneyShow in Chicago and I’m here with Dan Keegan and we’re going to talk about the volatility and where it’s been and where it’s headed.

Yeah, earlier in the year there was a lot of up and down in the volatility and it’s kind of a trader’s dream as you get a pop in the volatility you can put on a spread that takes advantage of it receding back to the norm, and when it’s low you can put on spreads. You can establish some spreads where if it pops you make money that way.  When it stays like this it makes it a little more difficult.

Right and it seems like volume’s been really subdued for the longest time.  I was kind of getting used to having the VIX around 30 or 40, and now when I see it at 15 I’m thinking what’s going on here.  It’s barely alive.

Right, as stocks creep up there’s over an 82% negative correlation between the VIX and the SPX, the S&P 500.  So, the stocks have been going up, like last quarter they’ve been up, but they go up and they creep up, and as they creep up there is a reason for a big demand for options.

As a result most traders have been trying at the low levels they tend to buy it and they don’t get hurt too much because it doesn’t really drop too much from where they buy it, but they don’t make any money either.

Are we waiting for volume to come back, for the VIX to come up, or is that just not really a correlation at all?  Is this the mean?  I mean have we just returned to the mean or is this as weird as it seems?

Well it’s kind of like 2005, 2006 when it fluctuated between nine and twelve for two years, which is really great for traders, and everybody was saying well the financial engineers have found a way to take volatility out of the market place and what happened in 2007, 2008, and 2009 was just insane.  At some point I mean the European, Europe will come crashing down or something will happen so that it will be a big sell-off in the market place, the VIX will pop and then stabilize and run back up and the VIX will come down.  That’s part of the trading environment.  You have to take the bad with the good, I guess.

Well it just seems like with all the market forces that are out there, the things that we see, the potentials, we’re in the middle of, I mean we’re having a Presidential election.  You have the fiscal cliff.  You have all these things and…

There should be volatility and there isn’t.

Right.  The market has ice flowing through its veins.

It’s just one of those things you could never predict what’s going to happen in the future otherwise we would all be trillionaires.

Right I guess so.  What’s your play at this point?  I mean what do you look to do?

I’ve generally been staying long volatility the past month or so.  It hasn’t been particularly profitable, but like I said I haven’t lost much money, either, because when it does pop, it will pop big.  The other thing is that the Jan, April, July, Oct cycle of earnings is upon us now, the October cycle.  YUM is the first one; it’s coming up on the 9th.  I think the 11th is Google.  Apple is after October expiration.  IBM is a few days before it, so there are some good stocks that are going to be having earnings and there will be different things we can do with that.

So hopefully there will be something to play moving into this earning season.

Right, exactly.  There will definitely be something to play on.  Earnings are a little tougher to play than normal trading.  Normal trading as it goes up and down you can kind of massage your position and make money that way whereas earnings is kind of a binary event.  Either it makes a big move or it doesn’t and you hope you’re right on what you set up.