Betting Against a Y2K Tech Explosion? Try Options

Pros wonder if it's time to 'sell premium' on tech stock options.
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It's Africa hot in technology stocks, with Internet and other issues such as

CMGI

(CMGI)

,

Inktomi

(INKT)

and

DoubleClick

(DCLK)

moving anywhere from 20 to 60 points in a matter of weeks.

Sharp stock moves like those are what set traders to sweating in the pits. To account for that uncertainty and the risk they're taking that the stock will jack-rabbit higher, they ratchet up the prices of options by increasing the volatility component of the contract's price. (Some other key factors are time until expiration and the price of the underlying security.)

With the

Nasdaq 100

up 15% since Nov. 5, it's no wonder traders are hot around the collar.

Here's where an opportunity arises for the investor: selling calls in tech stocks, making a bet that the high volatility traders price in will have to come down as the sector stops to take a breather. Betting against tech stocks after the past few months may sound like a tough sell, but if an investor believes the uncertainty around these names -- if not their actual stock price -- is ready to decline, there can be some benefits.

"People are looking for angles to play these high volatilities" in individual tech stocks, says Paul Foster with

1010wallstreet.com

in Chicago. And Rob Sorrentino, head of

Sorrentino Asset Management

, agrees: "Not this week, but maybe next Monday, I'd start putting on trades like that. It's not worth it to do so until the beginning of next week, which is the wind-down to December expiration," Sorrentino adds.

This strategy is known as "selling premium" -- in this case, meaning to sell high-priced calls with the expectation that the price will come down as volatility in the underlying stocks deflates.

CMGI and

Oracle

(ORCL) - Get Report

have had some of the most dramatic moves. Volatility in Oracle's at-the-money options clocked in at 51 roughly one month ago, around its average for the past six months. January 80 calls, however, are posting volatility of 68 to 69 this Monday. CMGI's volatility one month ago was 64; on Friday, volatility for at-the-money calls was 90.

"It's what's known as a melt-up," says Sorrentino of the tech stocks. Selling January call options in some of these tech options, he adds, "would be a great play going into the end of the year. Selling January premium means there's no tax implications for December and you capture a lot of the excess volatility."

In plain English, that means if investors were to sell calls expiring in January -- many of which may be pricing in unrealistically high volatility -- they could skip the December worry and potentially make money. He recommends selling tech stock calls in Inktomi,

America Online

(AOL)

, DoubleClick and

Echostar

(DISH) - Get Report

"a strike or two out of the money. You still get an enormous amount of erosion and some fat premium." (Currently, Sorrentino does not have any of those positions on -- at least, he says, not yet. He's waiting until next Monday to avoid a possible run-up in the stocks again this week.)

Inktomi shares are up 14 3/8 to 159 1/2, and its January 180 calls are fetching 11 3/8 ($1,137.50). On the Chicago trading floor, options traders are bidding 8 3/4 ($875) for the January 190 calls.

Internet blue chip AOL is up 2 1/2 to 80 7/8, at midday Monday, and the January 85 calls are up 1 ($100) to 6 1/4 ($625) per contract.

CMGI shares are up 8 9/16 to 168 15/16, and January 175 calls are up 5 3/8 ($537.50) to 21 3/8 ($2,137.50).

Call sellers typically want to be holding the underlying stock so that if they're forced to fulfill the obligation to deliver shares to the call buyer or want to buy the options back, there is some upside to offset the costs of doing either.