Call Option Plays Tilt Toward a Quick Post-Fed Rally

One covered call writer is betting a market spike won't last long.
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Sell into the rally.

And on Tuesday, some smart options traders were doing just that as they continued to play expectations of the

Federal Open Market Committee

erasing uncertainty surrounding interest rates.

Options Buzz: Join the discussion on

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Message Boards. Uncertainty, more than anything, drives markets, and regardless of what the Fed does Wednesday, traders are expecting a rally just by dint of the fact that the rate hike will finally be quantifiable.

Ahhhhh. Now we can relax.

Options traders often play this kind of activity by selling call options into a rally, a risky, but potentially lucrative way to play a spike, especially if you believe that prices are likely to snap back shortly. By selling, they get paid to take the risk that they'll have to deliver shares of a stock at a predetermined price if the call buyer exercises the option.

Jordan Kahn of

Kahn Asset Management

, for instance, is considering selling what are known as "covered calls" into the hoped-for stock market rally Tuesday. The calls he is thinking of selling would be "covered" by stocks he already owns:

Qualcomm

(QCOM) - Get Report

and

JDS Uniphase

(JDSU)

.

And Kahn believes after the rally, "we're in for a tough time, with the market in a trading range and the volatility through the roof. All I will be trying to do is increase my incremental trading profits."

Options have a finite life span, and as they age, their value begins to evaporate. If Kahn does decide to sell Qualcomm, JDS Uniphase or

Goto.com

(GOTO)

call options, he'd be selling February-dated options, since there's only a few weeks of life left in them.

As a seller, that's good because you get rapid time decay, and that's the main reason to sell near-term options. If I were a buyer, and trying to play price movement, I'd rather buy them in March or further out to give myself time to play potential price movement.

Kahn says his preference about which options to sell is to look at the volatility of the underlying stock. He likes the

Chicago Board Options Exchange's

Web site, which details the prior month's historical volatility for options. Goto.com has an implied volatility of around 155, and Kahn is betting that has got to come down; therefore the value of the calls he sells will come down as well.

Kahn isn't just a seller though -- he's also bought some

(QQQ) - Get Report

, or

Nasdaq 100

unit trust, March 180 calls. It's consistent, he adds, with his strategy of buying longer-dated options to give a bet more time to play out.

"If we get a rally and volatility stays high, I might simply sell the March 180 calls. Or I could sell some QQQ March calls at a higher strike price," Kahn said. That's what's known as a "spread" trade.

The QQQ is up 3/8 to 179 3/4; February 180 calls are fetching 8 ($800), while the March 180 calls are trading at 13 3/8 ($1,337.50), up 1 5/8 ($162.50).

General Motors

(GM) - Get Report

bulls may be coming out of the woodwork in the options markets.

With the stock up 1 to 81 9/16 at midday, open interest was continuing to build in the company's out-of-the-money February 85 and 90 calls, showing some investors may be looking for strong movement in the stock price in the next three weeks.

On Monday, each of those options traded more than 1,600 contracts as open interest built to around the 5,000 level in each.