Using Options to Bide Your Time

What indifference a week makes. If anything, the malaise and discontent I spoke of last week has only deepened as the issues confronting traders -- the election, rising interest rates, declining earnings growth and the ubiquitous orange cloud of terror -- continue to hang over the market as we enter the dog days of summer.

Option trading volume on Monday, the day we went on orange alert, was just 3.1 million contracts, the second-lightest day of the year. Only the Friday before Memorial Day generated less activity.

Unfortunately, this lack of options activity is a reflection of the low volume and disinterest plaguing the underlying market and it has bearish overtones for stocks in the near term. While bulls need growing volume and more new investment dollars to take prices higher, the bears know that stocks can fall of their own weight simply from a lack of demand. No volume is necessary.

In this environment, patience and safety should define your approach to trading. Thankfully, because recommending that traders simply stand aside is neither compelling reading nor helpful in generating profits, we have options to provide a large measure of both safety and profits. (Reading pleasure will probably remain elusive.)

Time Is Money

As volume is a weapon of the stock market, time is the option trader's double-edged sword. Knowing the impact and using theta to your advantage is one of the keys to choosing the right strategy, especially in a low-volatility, range-bound environment.

Peter Zomaya, an instructor with Optionetics, says, "Because the market will likely stay in a range, with the S&P 500 trading between 1050 and 1100 between now and the election, it's a great time to buy calendar spreads." A calendar spread, sometimes referred to as a time spread, involves the sale of a nearby option with the simultaneous purchase of one option with the same strike price but a longer life span or expiration period.

The main advantages of buying an at-the-money calendar spread are that the sale of the near-term option reduces the effective cost of the longer-dated option purchased, it benefits from the acceleration of time decay in a market with little price movement, and it benefits from an increase in implied volatility.