VOLATILITY ALERT: Fear Indices Fall Sharply on Bullish Week for Stocks

After hitting nearly a five year high in the prior week, the CBOE Market Volatility Index () fell sharply this past week to 20.72 from a close of 29.99 the week before. The Nasdaq Volatility Index () also fell sharply, down 23.48 percent to 20.69. This drop in fear could be saying that traders feel the worst is over, but low volume figures this past week show uncertainty.

The Fed continued to add liquidity this past week and the feeling is that they are making headway. However, traders would like to see a cut of the Fed funds target rate. Fed fund futures are pricing in at least a 25 basis point cut on or before the September FOMC meeting. The problem is that the housing sector remains weak and the credit markets could still worsen, but the markets usually do climb a wall of worry.

High Volatility:  VNDA shares have been consolidating the past few weeks as traders await news from the company. VNDA is looking for a partner for its schizophrenia drug, but has yet to find one. Nonetheless, implied volatility on the stock’s options remain very high. Though news could come at any time, we can enter a butterfly trade on the stock with a very strong reward to risk ratio. If the news does not come before September’s expiration, we could see a nice profit with very little risk. Even if the stock does move sharply, we are able to enter the trade with a small amount of risk. Make sure to look at both calls and puts when entering the butterfly to see which is providing the best reward to risk ratio. Currently, by getting in the spread and using calls, we can create a butterfly that has a 4-to-1 reward to risk ratio.

Low Volatility: One chart pattern that is nice to see is a triangle formation. This is when the highs and lows for a stock are narrowing. This normally is a sign that an impending move is in the works. The nice thing is that as the stock consolidates, it usually results in lower IV for the stock’s options. This looks to be the case for CELG so traders might want to look at using a straddle or strangle to take advantage of low IV and what should be a large move in one direction or the other. Biotech stocks do tend to show a lot of volatility so when IV is down, it is usually a good time to enter these types of strategies.

Jody Osborne

Senior Staff Writer & Options Strategist

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