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Weekly Stock Market Commentary 7/8/16

By Lawrence G. McMillan

The broad stock market has been able to consolidate its strong post-Brexit gains. There was a day and a half of selling this week, but a strong upward reversal by $SPX from 2074 on Wednesday leaves the bulls still in control.However, there is frustration for the bulls, too, because $SPX has not been able to assault the all-time highs. A promising Thursday rally failed at the 2110 level, reinforcing the 2110-2120 area as strong resistance.

Option Basics: Time Decay (06:06)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 6, No. 6 on March 27, 1997.

I was tempted not to label this article as a "basics" article, because the concept we're going to discuss is one that is probably not all that familiar to most option traders. It concerns the rate of decay of in- or at-the-money options versus that of out-of-the-money options. It's a concept that I realized I understood subconsciously, but not one that I had thought about specifically until I recently read Len Yates' article in The Option Vue Informer. Len is the owner and founder of Option Vue, creator of the software package of the same name and is one of the best option "thinkers" in the business (we are going to have a review of Option Vue when their new version is released).

What Volatility To Use? (07:06)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 7, No. 6 on March 26, 1998.

There are only two types of volatility – historical (also called actual or, sometimes, statistical) and implied. Historical tells us how fast the underlying security has been changing in price. Implied is the option market’s guess as to how fast the underlying will be changing in price during the life of the option. It’s easy to see that these might rightfully be completely different numbers. For example, take the case of a stock that is awaiting approval from the FDA for a new drug application. Often, such a stock will trade in a narrow range, so historic (actual) volatility is low, but the options will be quite inflated – indicating high implied volatility that reflects the expectation of a gap in the stock price when the FDA ruling is made.

Option Basics: Just Why Is Volatility So Important? (04:04)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 4, No. 4 on February 23, 1995.

If it seems that we preoccupied with volatility, it's because we are. It is the only variable factor in determining the fair value of an option; the others are known with certainty at any point in time — strike price, time remaining until expiration, stock price, dividends, and short-term interest rates. However, it has practical and real application as well. If you buy options when volatility is low, then you stand to gain doubly if volatility increases. Or, even if you're wrong on the direction of the underlying market, your loss will be reduced if volatility increases. Some examples may help to clarify these points.

Option Basics: Implied Volatility (05:09)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 5, No. 9 on May 9, 1996.

The concept of volatility, and especially implied volatility is extremely important for option traders. We often refer to implied volatility, for it is the foundation of many of our strategies. However, when meeting the public, I find that many people don't have a clear concept of what implied volatility is, so this article will be educational for some readers, and merely review for others.

Option Basics: Equivalent Positions (4:18)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 4, No. 18 on September 28, 1995.

The concept of equivalent option positions is an important one, for it is often possible to substitute one strategy for another. In so doing, one might be able to accomplish additional goals while still preserving the same profit potential. These considerations might include decreased commissions, tighter markets, or better use of capital.

Volatility As A Sentiment Indicator (13:6)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 13, No. 6 on March 25, 2004.

We have written about volatility many times in the past, but the “best” use of $VIX is that it spikes up to a peak when the market is collapsing, and then comes slicing back down when the crisis – whatever it is – has passed. Recently, in Volume 13, No. 4, we showed the entire history of $VIX, including the hypothetical history back into the 1980's. It is evident from that chart that spike peaks in $VIX are major buying opportunities. On a short-term basis, minor $VIX peaks are also good buying opportunities. The reason that this is true is generally that traders rush in to overpay for put options (insurance) when the market is collapsing. Imagine how expensive hurricane insurance would be if you waited until the clouds were on the horizon before purchasing it. The same thing applies in the stock market. When put premiums are cheap, as they were for the last eight months, no one wanted to buy them, but when the market broke down – exacerbated by terrorist fears – many rushed in to buy what had become relatively expensive puts.

Option Trading: Theory vs. Practice (19:02)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 19, No. 02 on January 28, 2010.

Over the years, we have written many times about the problems in predicting or estimating volatility. However, it is necessary to attempt the task, because it is so crucial in determining which (option) strategies can be used.

Option Basics: Volatility (3:21)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 3, No. 21 on November 17, 1994.

Volatility is merely the term that we use to describe how fast a stock, future, or index changes in price. When we speak of volatility in connection with options, there are two types of volatility that are important: historical volatility, which is a number that can be calculated mathematically by seeing how fast the stock has been changing in price over the past 10 days, 20 days, or any other time period that we want to examine. The other type of volatility that is important for option traders is implied volatility. Implied volatility is what the options are "saying" about future volatility: if it is high, then the options are predicting that the underlying instrument is going to become more volatile in the (near) future; if it is low, then the options are predicting that the volatility of the underlying will decrease. Thus there may be a difference between the historical and implied volatility. If the difference is large enough, then one can use options strategies to create a position with an "edge" — the "edge" being the differential between these two types of volatility.

Option Basics: Early Assignment Risk on OEX (5:15)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 5, No. 15 on August 8, 1996

Most stock options and a few index options are American style, meaning that they can be exercised at any time during their life. Most index options are not American style, but are European style, meaning they can only be exercised on the day they expire. Large institutions — many of whom sell index and sector options to hedge portions of their portfolios — prefer European style exercise because they then know they can't be called out of short positions prematurely. However, OEX options have always been American style. This makes them more interesting, but it means that one has to be on his toes when he is trading spreads in OEX — either debit spreads or credit spreads — if short options in the spread become deeply in-the-money.

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