Deposit Bank Options in Your Portfolio

The result was that the SMH and all the components mentioned were at higher prices when their August options expired just five weeks later, producing a modest profit equal to the total premium collected or the position's initial net credit. A minor victory, and also consistent with the fact that dispersion trading is a game of inches; this one gained a few.

I think where I went astray was using a short time frame and offsetting the SMH position with issues that carried little weight in its pricing. If I had bought options with a longer life span, it would have allowed for the thesis to play out.

As it turns out, current prices show that the short SMH puts would still be out of the money and essentially worthless, while the ultimate decline in the share price of KLA-Tencor and Novellus have sent their long puts into the money, giving them an intrinsic value of about $8 and $7, respectively. Oh, those would have been salad days! But enough rehashing of leftovers; it's time to look for ways to take the current market roughage and create a feast of profitability.

Getting Larger and Longer

This time, the more attractive strategy will look to take advantage of the greater discrepancy between implied volatilities. Citigroup and J.P. Morgan puts are currently sporting implied volatilities of 25% and 28%, respectively, both of which represent their highest levels in the past 52 weeks and well above the historical average of 10%. Put options on the BKX currently have an implied volatility of 19%. While that's at the upper end of its range, it's only moderately higher than its historical average of 12% over the last 52 weeks.

I also want to take advantage of Citigroup and J.P. Morgan accounting for nearly 30% of the weight of the 24 companies that comprise the index. If you include J.P. Morgan's recently approved acquisition of Bank One(ONE Quote), that weighting will go up to 35% of the index. This means I only need to sell puts in two companies (that I'm willing to buy at lower prices) to essentially track the BKX, which keeps the number of transactions and commission costs down.