Dykstra: Volatility Drives Up Premiums

Market volatility plays a major role in the premiums on options. A glance at the Chicago Board of Options Exchange's Volatility Index, which gauges market risk, shows just how much: From August 2007 to September 2008, the VIX stayed within a range between 17 and 30.

With increasing market turmoil, the index began to soar in mid-September to a range between 50 and 80, and options premiums rose along with that higher expectation of volatility. By December, many of the picks in my deep-in-the-money call options strategy were being cancelled because of failure to fill at the price I wanted to pay.

My strategy, which you can follow through my Nails on the Numbers newsletter, has given me a win record I'm proud of: 95-1 to date. The rise in market volatility leads me to today's question from a subscriber:

Why are the premiums you are willing to pay sometimes below the premium available that day?

Markets have recently been much more volatile than normal. That volatility is good for option positions, but you have to be careful when and how you get in. It is important not to overpay on a premium. So stick to my recommendations -- they work.

However, I do understand that options going out to 2011 sometimes trade much higher than my recommendations. Given market volatility, investors have been willing to pay higher premium costs.

The intrinsic value of these longer options is much higher than shorter-termed options. So while it is possible to pay the higher premium and hope for the best, chances are you will be holding the option much longer to get your win.