SCENARIOS: Options strategies to trade recent volatility

NEW YORK, May 14 (BestGrowthStock) – The unexpected plunge in
stocks on May 6, followed by a last-minute $1 trillion package
to save the euro, has investors looking for ways to hedge
against surging volatility across markets.

Stocks have been whiplashed since the plunge that
momentarily wiped away $1 trillion of value last week, and Wall
Street’s fear gauge, the Chicago Board Options Exchange
Volatility Index (.VIX: ), has rocketed from trading in the
mid-teens at the end of April to 42 on May 7.

One-month euro/dollar volatility, a key gauge of fear in
the currency market, had surged to a more than one-year peak at
17.0 percent hit last Thursday at the height of the meltdown in
global financial markets. On Friday, it fell to around 14.40
percent.

Gold, a favorite safe haven in uncertain times, rose to a
record high of $1,248.95 an ounce on Friday in London.

Safe-haven flows also moved into U.S. Treasuries. Last
Thursday, the stampede into U.S. government bonds pushed the
spot CBOT 30-year Treasury futures contract (USc1: ) to its
highest in more than a year.

The following are some strategies on how to take advantage
of market volatility:

SPDR GOLD TRUST

Analysts expect to see further market volatility and more
record highs fueled by strong demand pouring into the gold
market from investors seeking safety against the possible
spread of sovereign debt problems in the euro zone.

Scott Fullman, director of derivative investment strategy
at broker-dealer WJB Capital Group, recommends the purchase of
a one-for-two ratio call spread in the SPDR Gold Trust (GLD.P: )
to capture a potential 8.2 percent gain in the world’s largest
gold-backed exchange-traded fund for the rest of the quarter.

The trade uses June 2010 options that expire on a quarterly
basis with a GLD share price of $120.10 traded on Friday.

Fullman says buy a GLD June call option at a lower $121
strike and sell twice as many calls at the higher strike of
$130, resulting in a $1.28 net debit.

The investor can make money between the trade’s two
break-even points of $122.28 and $137.72 by the end of June.
The maximum potential profit is if the shares reach $130 at
June quarterly expiration. The trade would begin to lose money
if the fund’s price exceeds $137.72, Fullman said.

EURO/DOLLAR

The $1 trillion European Union package has reduced the
“extreme tail risks” that investors feared, said Aditya
Bagaria, currency derivative strategist at Credit Suisse in
London. But he cautions that short-term uncertainty should
linger, keeping euro volatility elevated over the next three
months.

Overall, he thinks the euro will remain under pressure
against the dollar in the near term at least.

“The euro hasn’t rallied a whole lot and we are in a
consolidation phase right now. I would short volatility in
euro/dollar because it is rich, but not on an outright basis
given all the uncertainty that continue to linger,” he said.

Friday’s level at 14.40 percent was still way above the
100-day moving average, which comes in at around 10.75
percent.

Bagaria recommended a reverse knockout put structure in
euro/dollar, a short-term bet against the euro zone currency.
But it would have limited downside given the EU bailout.

With this trade, an investor purchases a one-month
euro/dollar put with, say, a strike of $1.23, but with a
reverse knockout barrier at $1.20. This will make money if
euro/dollar falls below $1.20, Bagaria said.

Bagaria said the trade is premised on the view that the
euro will trade between $1.23-1.20 over the next month, which
he believes is a reasonable short-term outlook in the currency.

But if euro/dollar were to fall to $1.20 over the next 30
days, then the investor would lose his put premium but not the
entire investment in the trade.

BETTING ON SPIDERS

Steve Place, owner of Web information site
InvestingWithOptions.com, recommends investors sell volatility
irrespective of direction.

Specifically, he said betting on SPDR S&P 500 fund (SPY.P: ),
an ETF commonly known as the Spiders that tracks the S&P 500
benchmark (.SPX: ), is a good strategy since the ETF is now
nearing a key resistance level at $118.50.

“As long as by next week the SPDR S&P 500 fund is below
that level it will be a profitable trade. This is a suitable
way to fade the movement we’ve seen over the past week, while
keeping proper risk management,” he said.

Specifically, an investor could sell May $118 call options
and buy May $119 calls in advance of their expiration on May
21. This is a way to short the market but limits his upside.

Currently this trade costs 44 cents, so the investor would
receive a credit of 44 cents and be risking 56 cents. The
break-even point is going to be the short strike plus the
credit, which would be $118 plus 44 cents.

The maximum risk the investor has is the distance between
the strike prices, which would be $1.00 in this strategy.

T-BOND STRANGLE

Stock gyrations have kicked up volatility in Treasuries, as
investors, who are nervous about the euro zone debt problem,
have been flip-flopping between the two markets, said Michael
Zarembski, senior futures analyst at optionsXpress Inc.

A T-bond options trade to hedge against the bond swings is
a short-term strangle in which a trader holds a position in a
call and a put option with different strike prices.

Zarembski suggests buying a July T-bond call at a strike
price $1 to $2 above the current level of the Sept T-bond
contract (USUO: ) and a July put at a strike $1 to $2 below where
the Sept T-bond is trading.

Stock Investing

(Reporting by Doris Frankel in Chicago; Angela Moon,
Gertrude Chavez and Richard Leong in New York; Editing by Dan
Grebler)

SCENARIOS: Options strategies to trade recent volatility