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Trading Volatile Options in World Changing Times

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Are Global Events Changing the Trading World?

by Mike Rykse

Being involved in the financial markets for the past decade I have been able to see many different market conditions play out. I have seen the market crash back in ‘08 and ‘10 followed by a move to all time highs ever since. We have had times of high volatility and times where watching paint dry sounds like more fun. However, when we take a look at today’s market does it feel like the game is changing? In the last year, the markets have brushed off terrible economic numbers which confirm the economy still needs time to recover. We have also seen global uncertainty caused by volatility in Japan and now the Russia/Ukraine crisis. After all this the markets are still up near all time highs. Traders and investors are showing no signs of fear and are buying every single downtick that this market shows. We haven’t seen a 10% pullback now in the last few years. Does this really mean everything is ok and we should all just continue buying the new highs? Let’s take a look at some ways we can approach these new market conditions and how trading volatile options can be used.

First, we have to acknowledge the presence of the Fed as a big player in today’s markets. The U.S. Federal Reserve has actually been joined by other countries in trying to support their economies. As a result of the historic monetary policies being used right now, we are seeing endless buying opportunities. There is no fear in the market because traders know the Fed is there to prevent any significant downturn. However, this approach is also coming with some consequences. We are seeing markets make historic moves higher towards all time highs. We are starting to see signs of bubbles in many markets which can be concerning. This also gives great opportunity as well if you know how to identify the right products. Take the movement in Natural Gas for example. Earlier in 2014 we saw a move to all time highs in Natural Gas. We saw endless buying for 6 weeks bringing this product into bubble territory. When you see movement like this in a product you have to be ready to act. Sure enough once we got to end of February this product had pulled back from the highs and did so very quickly. Instead of being paralyzed by this move you have to be ready to profit when the markets turn. We made good money on the pullback in NG by selling Call Options and Call Spreads because we were able to spot opportunity.

 

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We are also seeing impressive moves higher in some of the grains and cattle products. While these aren’t popular products with many retail traders it’s important to recognize the moves. Feeder Cattle is a market that has been limit up a few times now in March. Prices in the Corn and Soybean markets have also been on the rise. What does this mean for us? It means we have opportunity in the coming months. It might mean we are trading products that are new to us but as long as I am making money I don’t care what the product is.

Stocks like NFLX, PCLN, and GOOG have also been relentless on the upside for the past 6 months and are now reaching levels where buyers will start to run out of steam. When these stocks turn it won’t come with advanced warning. Traders will rush to the exits all at once meaning you have to ready to act. I love when these situations develop because these turns can provide incredible profit potential. Using simple strategies like long Put Options or long Vertical Spreads give you a chance to profit from these quick moves lower. Having the ability to spot opportunity is something all traders have to learn how to do. Don’t get suckered into buying new all time highs day after day. If you are ready to spot market extremes you will see some of the most profitable trading of your career when those markets turn.

Markets can’t move to all time highs on an endless basis without a series of pullbacks along the way. When you take a look at the overall market using a product like the S&P 500 it’s easy to see a market that is due for one of these pullbacks. That doesn’t mean it has to happen tomorrow or next week. It does mean we have to be ready to play that 5-10% pullback when it does happen. One of the products to watch for signs of a market turn is the VIX. The VIX is a product that tracks the levels of implied volatility in the S&P 500 Index Options. It’s an important product to track because we won’t see the pullback without the VIX spiking up. Looking at the current levels of the VIX in the 14.00-15.00 range is a sign of low fear. I am looking for a move to the low 20’s in the coming months which should also mean the market is rolling over. There are a few ways to profit from this move. First, you can trade an ETF like VXX which tracks the movement in volatility. This product does offer options, which makes it very attractive for smaller retail traders. Should we see the market rollover and volatility expand that will give us the opportunity to profit with a product like VXX Call Options.

Even with all the global events causing economic uncertainty there are still great opportunities if you are willing to think outside the box. This could involve trading markets you have never considered before. Spotting short term opportunities in these markets that are at extremes will become more important than ever in the coming months. In my opinion, volatility has been low for way too long. The move in Natural Gas is a perfect example of what happens when a market gets to an extreme. The overall equity markets are reaching extremes and as traders we need to be aware of that. We need to be ready to profit from markets turning quickly because when fear kicks in things speed up. It’s not a time to jump out of the markets due to fear of a pullback. It’s time to take advantage of products like VXX and Equity and ETF Put Options to profit from the move lower. Stay flexible and we could all be in for a really fun rest of 2014.

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