Where is Volatility Headed?

11/07/2013 6:00 am EST

Focus: OPTIONS

James Bittman

Senior Instructor, Chicago Board Options Exchange

Closing in on the year end, the CBOE's Jim Bittman talks about where he believes volatility will be at year end and the best strategies to use in the current environment.

SPEAKER:  My guest today is Jim Bittman.  We're talking about volatility.  It's been low for this year, is it going to stay that way?  Jim, what are your thoughts here as we come into the end of 2013? 

JIM BITTMAN:  Well, Tim, that is the $64,000 question, and I can tell you that if the market goes down, volatility will go up most likely, and if the market reverses and goes back up, volatility will go back down.  My thinking is that it will stay above its recent lows until we get back in a decisive uptrend, and I think that's a ways away, so the name of the game is to trade spreads to protect yourself against a decline in volatility, but unless you get the direction right, you've got to stay spread so that your losses are held in a reasonable level. 

SPEAKER:  Let's talk about an example of a spread.  Give us a kind of a garden variety spread trade that you could do this with. 

JIM BITTMAN:  Well, a classic bear put spread.  If some stock is trading at 100, you would buy a 100 put and sell maybe a 90 strike put, and if the market goes down we've got 10 good dollars on the down side, $10 move on the down side.  If the market goes up, then that put you sold will help a little bit in reducing the loss of the put that you own. 

SPEAKER:  If I've got a basket full of stocks, maybe not a ton, but just eight or nine in my portfolio, should I try to do this on each individual stock or maybe just do something on the S&P 500 overall to protect me on all of those? 

JIM BITTMAN:  Well, if you're highly concentrated in one industry, like if you own nine technology stocks or nine oil stocks, then there are sector indexes on which you could buy a put, but if your nine stocks are really well diversified, then buying a put on the S&P 500 or the NASDAQ 100 or the Russell 2000 would certainly be a viable alternative. 

SPEAKER:  All right, and if I'm of the mind that the market is going to correct here, because it's high and the fed and government politics and all that, how am I going to profit from a rise in volatility? 

JIM BITTMAN:  Well, you just asked about a directional play, and experienced traders have to separate out a pure volatility trade from a directional trade, so if you believe the market is going down then you either buy puts or sell bear call spreads, something like that, but if you really think volatility is going to go up, then you could buy a straddle something of that nature.  We're coming into earnings season, so volatility has begun to rise but it might not be too late to buy straddles on certain stocks. 

SPEAKER:  Jim, thanks for your time. 

JIM BITTMAN:  Glad to be here, Tim. 

SPEAKER:  You're watching the MoneyShow.com video network.

Related Articles on OPTIONS