The Fed punts and option premiums rise | Options Trading Strategies

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The Fed punts and option premiums rise

Tuesday, 16 September 2008 10:31 Written by John Jagerson

Option Market Outlook: 16 & 17 September 2008

The market has been up and down today as traders try to deal with how the financial sectors have changed forever and the Fed's announcement to not raise or lower rates but to punt or gamble on whether the markets can work themselves out without the boost of lower rates. Due to the upheaval traders are pushing volatility and therefore option prices very high. This can be a very tempting time to become an options seller but the reason premiums are so high is because the risk of disruptions are very high. This is not necessarily a reason to avoid selling options but it does mean traders should have a greater emphasis on diversification and risk control.

On the economic front the big news was an easing of inflation number due to a decline in energy prices and an announcement from the Fed Open Market Committee to hold rates at 2.00%. Traders will probably feel that the lower inflation numbers will ease some of the pressure on the Fed to raise rates in the near term, however, it is important to remember that but CPI has never been very predictive for longer term market trends or the Fed's behavior.

In the video I will also talk about what affect the Merrill Lynch (MER)/Bank of America (BAC) deal is having on the prices of those two stocks.

Preview: 17 September 2008

News coming out of the financial sector will still be dominating traders and trader sentiment for the rest of the week. Developments in AIG, pending acquisitions like Merrill (MER) and the sale of Lehman's assets are wild-cards that will keep risk very high. None of these are gauranteed to conclude successfully and that will keep premiums high. This means that more neutral long options strategies are attractive (if somewhat expensive.) In the video I will outline a simple way to take advantage of some of the volatility in the financial sector by looking at a neutral long straddle on a banking ETF.

One of the great tools that can be used to control risk and make profits in a volatile market are covered calls. Check out this article about covered calls here.

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