Uncertainty feeds a surge in U.S. options trades

* Volatility at around 20 is near historical average

* Market dips creates opportunities for option bulls

By Doris Frankel and David Gaffen

CHICAGO/NEW YORK, March 4 (Reuters) – The equity options
market has attracted a huge crowd of U.S. investors trading in
a marketplace where daily surprises come from all parts of the

The stock market has been resilient, but the threat of
rising oil prices has tempered bullish enthusiasm, judging by
lackluster share volume on days when stocks have rallied.

“The recent see-sawing in the market has led to an
increasing number of investors saying ‘I don’t know’ when it
comes to their market forecast.” said Jason Goepfert, president
of sentimenTrader.com.

Those worried about doubling down on the big market gains
are using options to stay in the game. While February is
usually a quiet month for trading, February 2011
exchange-listed volume was up 35 percent from the year-ago
period at 354.2 million contracts, the eighth heaviest month

Options are still relatively inexpensive, so investors can
shift to option strategies to get upside without risking the
money they would in the cash market.

The Standard & Poor’s 500 index (.SPX: Quote, Profile, Research) has gained 27
percent since Sept. 1, and corrections have been mild.

Lately, though, the rally has stalled. So some investors
can remain bullish, but hedged, by selling some stocks and
buying call options, contracts that give the right to buy the
stock at a fixed price any time up until expiration.

The CBOE Volatility Index (.VIX: Quote, Profile, Research), which gauges investor
sentiment and market risk, has lately been hugging the
long-term average of 20 compared to a spike above 40 following
the May 2010 “flash crash.” For a graphic on volatility, click
here: http://r.reuters.com/guf48r

The cost of options on stock indexes are at reasonable
levels, but there are worrying signs. The S&P has experienced
four days of 1 percent losses since Jan. 28, and some believe
that presages a rise in volatility.

“This increase in magnitude and frequency (of down days)
should keep the market edgy and volatility expectations
elevated,” said Dan Deming, managing director of options
trading firm Stutland Volatility Group in Chicago.

During this period, Stutland advised investors who are
looking to buy dips to purchase call spreads as opposed to
buying the stock or benchmark.

For example, buying the April $82-$85 call spread in the
iShares Russell 2000 Index Fund (IWM.P: Quote, Profile, Research) would still allow an
investor to participate in the continuation of the uptrend but
limit downside exposure, he said.

Joe Cusick, senior market analyst at online brokerage
optionsXpress in Chicago, suggested stock-replacement
strategies, where one sells an equity position that has
appreciated and replaces it with longer-dated call options.

“If you still have your convictions, it does not mean they
have to be abandoned,” Cusick said.


To be sure, some still foresee a correction, and investors
have been hedging portfolios in recent sessions.

In the SPDR S&P 500 fund (SPY.P: Quote, Profile, Research), the bearish sentiment is
reflected by a high skew, a premium given to out-of-the-money
puts relative to out-of-the-money calls, according to the
latest weekly data.

“The recent volatility skew for SPY options expiring in
April and May has reached levels not seen since last fall.”
said Jared Woodard, principal at research/ trading firm Condor
Options. “This suggests increased demand for downside puts.”

This is still a buying opportunity, “but for investors who
are uncomfortable this may be a warning to downside some stock
positions or put on some protective strategies,” said Randy
Frederick, director of trading and derivatives at Charles
Schwab & Co in Austin, Texas.
(Reporting by Doris Frankel; Editing by Leslie Adler)