News Events & Options

03/14/2013 1:00 pm EST

Focus: TRADING

Brian Stutland

Managing Member, The Stutland Volatility Group

Some experienced options traders use options to position themselves ahead of a news event. CNBC's Brian Stutland explains the pros and cons of this approach.

My guest today is Brian Stutland.  He is a contributor to Options Action on CNBC.  We're talking about trading options around news and economic events.  So, Brian, I know a lot of people if they feel if the nonfarm payrolls are going to come out, it's going to be a good number and I'm going to buy a call on the S&P but there is a lot of risk involved there.  What advice do you have?

Yeah if you're always out there just buying options blanketly, you are at risk, because typically options are slightly overpriced compared to actual realized moves.  Alright, so you definitely have to have a bias of the direction of the market.  That's a great starting point and you said yourself, I think the non-arm payrolls are going to be good.  So there's my bias, right.  I think to the upside, so I'm going to buy a call. 

Now, the math is starting to work a little bit better in your favor and these weekly or short dated options are a great way to either protect yourself to the downside or play to the upside, but you have to keep in mind, once that week is done, the option is gone.  So when you get that move, you either have to close that position out or look to roll it.  I mean, you really have to stay on top of it.  It's a one-time event and so you have to look at the price of that option and see if it makes sense that you can actually get that gap moved through that strike.  Otherwise, you actually should be the seller of that options strike. 

I know a lot of retail traders just outright buy or sell a single call or put, depending on what their bias is.  It seems more professional traders are always doing spreads or some sort of iron condor.

Yeah.

Or ways that they can be sort of right in that range, but that seems to be the next step, right?

Yeah, well, for example, what we do with some of these weekly options is we do like to buy them going into a news event.  But we typically do that to add protection if we are short volatility.  Let's say we are short a put at a level that we want to get into a stock or we're short a call that we're willing to get out, we may use that weekly option to buy and protect in case there is a tremendous move against you there and if you're wrong, well, you only spent a little bit premium for that weekly option compared to all of the premium that you would collect over that time. 

Once the event is done, hopefully the rest of the time premium comes out of those later dated options and you can start to profit from that.  So they're a good way to protect yourself, so to speak, rather than initiate positions.  But certainly, we see that all of the time.  We saw one institutional trade, a big put buy into the SPDRs, headed into the Fed announcement, they were trying to make a weekly bet to the downside.  Apple weekly options get very active to the upside if there's an event coming out, people trying to buy calls.  So there is definitely a new nuance to the marketplace right now.

Alright, and then finally, what about using say just the put call ratio or just options in general to get an idea of what people think is going to be the outcome of the news announcement?

I think that's a great way to look at it.  Put-call ratios are an interesting tell on where people's shift of opinion is and whether they want to be hedgers, you know, then you'd see the put ratio rise, and if they want to be long call, you typically would see the call is traded a little bit more active.  One thing we actually do on Optionsaction.cnbc.com, I write a blog, we give a couple of insights of big institutional trades that go up to try and give investors insight on whether the direction of that underlying asset class, what direction that's going and where institutional traders are betting on.  It's nice to see where those big options activity is occurring at.  Sometimes that's a tell in the direction of the stock price.  So looking at open interest and volume in the options market is big.

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