One thing is for certain from the last few day’s yoyo action in the equity markets; the volatility bands that blew out are likely to stay elevated for some time. Obviously in hindsight the VIX at 15.50 in early July was a gift to those looking to use options for portfolio protection or to express directional views, but the likelihood of seeing sub 20 readings anytime soon are not likely. Investors/traders by now should be braced for a period of heightened volatility and adjust their portfolio holdings accordingly.
Just as the market might have overshot on the downside in such a short period of time, we are likely to see exaggerated moves in single stock names where implied vol will stay well bid. So I guess the point here is consider using options in this environment for 3 main reasons;
1. risk management, use options to define risk either to express directional views or to replace long or short stock positions with the potential for long premium structures to benefit from spikes in implied volatility. If you are looking to protect longs consider using spreads to mitigate the cost of buying expensive options and for the more sophisticated investor/trader consider ratio spreads.
2. yield enhancement, look to take advantage of elevated volatility to overwrite your most convicted longs. always choose levels where you would sell the stock when choosing strikes and consider the % of the underlying in the premium sale and whether the risk of being called away is worth the yield and the potential buffer to the downside.
3. leverage, lots of people here will want to play catch up as under-performance by mutual funds and hedge funds is likely to be extreme as many got caught off guard by this downdraft….consider how much you are willing to risk to commit premium to your most convicted ideas to play for an out-sized return if you get the sort of move you are looking for.