October's Chills Thrill Options Traders

A few strategies stemming from a summer of subdued strength.
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The summer was a hot and lazy one, remember? The stock market was drugged, and no one, including hedge fund manager Adam Benowitz, was into buying the standard, knee-jerk hedge --

Standard & Poor's 500

, or SPX, index puts.

He had no conviction. Everyone was short, or selling, puts. No one was buying puts. "No one, I'm telling you," he remembers.

So it was time to buy puts. Benowitz, manager of

Apex Capital

in Spring House, Pa., bought some then-out-of-the-money SPX December puts with low-1,200 and high-1,200 strike prices. He wouldn't say where exactly he bought them, but prices back in August ranged from around 18 ($1,800) to 50 ($5,000).

Friday, two months after he almost didn't buy them, December 1,200 puts were trading at 33 1/4 ($3,325) and December 1,295 puts were at 71 1/4 ($7,125). The OEX -- the

S&P 100

-- at the end of August traded at around 700; Friday it closed at 672.

What made Benowitz wake up from the siren song of the hot summer and remember the October chill? "No one believed the market was going to go down. Even I didn't believe the market was going down," Benowitz said. "This time I was


going to buy puts. For the last eight years I would buy puts and I was always wrong about the market going down.

"And I finally said in August, 'Screw this. I can't not buy them. Because if I don't, the market will go down this time.'"

October was coming and "puts were getting obscenely cheap all over the place. People didn't believe the market would do anything but go up in an orderly way 50 points a day for the rest of their lives."

This is the way options work sometimes, as an indicator of complacency: Everyone's running to the sunny side of the ship. And then it tips over.

Which indicators were most unsettling to Benowitz amid the languorous August days? For one, the market's fear seemed to shrivel like an old man in the fields. The key index this past summer was the

Chicago Board Options Exchange

volatility index, a percentage clocking just how much stock prices are expected to swing on an annualized basis. It was trading around historic lows.

Think of the VIX as a heat-seeking worry sensor, and it was down to 18% to 20% this past July and August.

Larry McMillan of

McMillan Analysis

also has a seasonal strategy -- and one that can still be put on. "It's a simple one: Buy the S&P 500 index options at the close of trading Oct. 27, then sell them at the close of trading Nov. 2 (or on the following Monday if Nov. 2 falls on a weekend)." For the past 21 years, he pointed out in a recent research note, it's been a decent short-term trade, with an average gain of 10 S&P points. Specifically, he recommends buying 2 November OEX calls that are in the money by one strike price: for example, the OEX currently trades at 651.6. So you would purchase the November 650 calls or 645 calls.

Why? "I suppose it reflects the fact that the market usually makes a trading bottom sometime in October," McMillan said.

Now that it's fall, and the scary stuff has emerged, Benowitz is putting his discipline to work again. He's selling a third of the puts he bought back this past summer. Just to be on the safe side.

Just because it gets colder in October.

Also, join us for an hourlong chat on options Tuesday, Oct. 19, at 5 p.m. EDT on Yahoo! when trader Lewis Borsellino will discuss daytrading options. Register at

chat.yahoo.com. It's free!