Beneath the Calm, Options Volatility Rises 12% This Week

With two weeks remaining before July expiration, options activity has slowed to a crawl. But beneath the quiet surface, volatility has climbed higher as corporate America unleashed a slew of earnings warnings.

Historically, the week of the Fourth of July holiday has been marked by light trading volume and increased volatility. Heading into the weekend, the daily option volume average stands at 1,373,781 contracts, compared with the 2001 year-to-date average of 3,323,685 contracts.

But the Chicago Board Options Exchange Volatility Index, which essentially gauges investor fear in the market, is up 12% this week. Since March 22 -- the day the S&P 500 reached its low for the year -- the VIX has dropped 35% from 39.70 to 22.72.

"If [volatility] were to begin to rise sharply, that would be bearish," says Larry McMillan, head of McMillan Analysis says. However, "the overall trend of volatility is still down. In that regard, then, volatility is still categorized as bullish."

Volatility Index
Today	% Change
24.85	+9.29%
Source: ILX 1:30 p.m.

Implied volatility will increase during periods of uncertainty such as earnings season or chatter about a possible merger. As a result of the recent volatility, option premiums have come down significantly, creating some good trading opportunities for investors, according to McMillan.

Nasdaq Volatility Index
Today	% Change
51.64	+4.45%
Source: ILX 1:30 p.m.

He contends that there are over 900 stocks whose options can be considered "cheap" right now. Among these are Albertsons(ABS Quote), Gap(GPS Quote), Philip Morris(MO Quote), Triton Energy(OIL Quote), and Royal Caribbean Cruises(RCL Quote).

As for index options, there are a number of cheapies for volatility traders out there too. However, when dealing with options an investor should always be wary of selling naked -- that is, to sell an option without having an offsetting position in the underlying stock. So before you go naked be sure to read Getting Naked by James Cramer and Selling Puts Naked Stripped This Investor of Most of His Assets by Dr. Don Taylor.