Options Fear Gauges Jump as Dow Plummets

For today at least, options market sentiment indicators said goodbye to the recent calm and comfort, and greeted anxiety and fear amid a steep selloff prompted by a healthy dose of bad corporate news.

Volatility Index
Today	% Change
33.34	+8.63
Source: ILX

The Chicago Board Options Exchange Volatility Index, or VIX, jumped 8.63% to 33.34 today after falling recently as the market rallied. Also, the American Stock Exchange's volatility index, or QQV, based on the options prices of the Nasdaq 100 Unit Trust (QQQ), better known as the QQQ, hopped 5.94% to 58.54 this morning after slumping lately. The QQQ fell 5.5% to $40.88.

Nasdaq Volatility Index
Today	% Change
68.61	+3.02
Source: ILX

The VIX and QQV for the most part have an inverse relationship with the market's movement. The VIX and QQV rise when the market sells off, and dip when the market rallies. Traders use the gauges as contrarian indicators, meaning that sharp extreme readings can help signal that the market is about to turn and rally. Last week the VIX soared to a 52-week intraday high of 41.99 amid a sharp selloff in the market. The market since rallied and the VIX plunged, falling back to a close of 30.69 yesterday.

Meanwhile, the stock market's plunge today was being blamed in part on telecom equipment maker Nortel (NT), which warned last night of an earnings shortfall for the third time this quarter and set plans to hack an additional 5,000 jobs. The company said it expects to post a bigger than expected loss of 10 cents to 12 cents a share, compared to the previous forecast of a loss of 4 cents a share.

Shares of Nortel were getting hammered, down $2.84, or 17%, to $13.92. Despite the sharp selloff in the shares, the prices for the options have not increased a great deal, according to some traders.

While the stock was getting crushed, there was some call buying in out-of-the-money calls expiring in September, said Alan Goldstein of Five Dollar Trading, a market maker on the CBOE.

More than 2,000 of the Nortel September 20 calls traded on the CBOE. The calls fell 1.45 ($145) to 1.10 ($110). By buying calls, investors are hoping that by September Nortel will have rallied enough that the relatively cheap wager in the calls will reward them with a tidy profit.

Goldstein said the implied volatility in Nortel options was "up slightly, but not a whole hell of a lot." Implied volatility is a key component of an option's price and the market's estimate of how much the underlying security can move. Implied volatility rises generally when demand for options increases.

Meanwhile, traders were taking positions in the Nortel April 12 1/2 puts, where 2,570 contracts traded. The puts rose 0.20 ($20) to 0.40 ($40) on the Philadelphia Stock Exchange. Open interest (the total number of options contracts that have not been exercised or allowed to expire) as of last night's close was 254 contracts.

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Van der Moolen, an options market maker with a presence on the Chicago Board Options Exchange and the Philadelphia Stock Exchange, is expanding to the American Stock Exchange and plans to acquire a 51% stake in Amex options specialist firm Cohen Duffy McGowan.

According to the Van der Moolen announcement, Cohen Duffy McGowan has a market share of 12% of the Amex's contract volume. Terms of the deal were not disclosed.

Cohen Duffy McGowan is a specialist for 125 options at the Amex, including General Electric (GE), ExxonMobil (XOM), Philip Morris (MO), Lucent (LU), Sun Microsystems (SUNW) and Merck (MRK).

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