Fear and Loathing in the Options Market

Despondency and Disengagement

Conventional wisdom surrounding options maintains that buying them can protect a portfolio against exactly the kind of sturm und drang the market's been experiencing since the credit drama first began. But traditional hedging strategies -- buying calls on the VIX and index puts on the S&P 500 (SPX) -- have been caught in the crosshairs.

Over the past month, a good many traders appear "damned if they do" -- paying top premium for long calls or puts that are increasingly hard to close out profitably -- and "damned if they don't" -- leaving portfolio holdings ravaged by the effects of unrelenting intraday swings in the market and terrifying tests of new lows.

Frederic Ruffy, options strategist at Whatstrading.com, notes that overall hedging activity using options has declined since mid-October, with a steady decline in VIX call volume since mid-September. "Since mid-October, it has not paid to have been an aggressive buyer of VIX calls, and buying SPX puts has been difficult because, although the index is still falling, declining volatility and time decay will work against owning index puts," he says.

Kevin Fischer, head of the block trading desk at Interactive Brokers, explains it thusly: "In a time of protracted high volatility, such as what we've experienced the past two months, option traders may find that their normal trading strategies do not work, and often lose money before heading for the sidelines. This also creates a kind of no-man's land, of shrinking volumes and wider markets, where option traders don't care to be long volatility, because they know eventually it will return to historical levels, but don't want to be short either because they know it can still go higher."