Options May Signal Revival for Some Dogs of '99

A rise in volatility can suggest upside speculation.
Author:
Publish date:

It's the end of the year. Time to give thanks for your family, eat too much during the holidays and consider your options.

No, not

those

options. Keep your fiance, don't quit your job. But take a look at the dogs in your portfolio and then check out their options, because they may be signaling a New Year's pop.

Tax-loss selling has been going on for quite a while now, and it is a popular strategy in the options market as well. So if a stock has sold off, it's worth taking a look at the equity options to poke the body and see if there's any life left.

Once stocks get near levels the market believes are close to the bottom, implied volatilities rise because market-makers expect some type of bounce.

And, hey, even dying dogs can bark one more time. Take

Sunbeam

(SOC)

, for example.

Options in this stock, which has dipped to a 52-week low of 4 this week, have seen the volatility spike to levels similar to that of an Internet stock for January- and February-dated options (back in October, volatility was around 69).

"Market-makers know volatility needs to rise because the stock had a dramatic spike literally on the first trading day of 1999," points out Paul Foster with

1010wallstreet.com

. "They learned their lesson last year, and they don't want to get caught again" and are pricing call options accordingly, he adds.

Volatility is the heartbeat of an option, and one of the most important factors in determining whether an option is cheap or expensive. Volatility is the percentage number that options traders plug in when they estimate how much the stock price is expected to move -- in either direction -- annually.

"Pick any stock that's had a bad year," Foster adds, then check to see if the volatility of the options has shot higher. That's an indication that market-makers in the options are pricing in a big move and won't price the options too low for fear of getting crushed.

"That's why I'm watching the tape today. I want to see the big prints going across in the stock and options," he adds. "It gives me more confidence about investing in stock. Just like options indicate a takeover, earnings surprises or other news, big option trades this week are premeditated, hints that sellers are all done."

Finally, options can also allow a true believer in a stock to take a tax loss and still stay long the stock. Here's another of Foster's candidates for the stealth options volatility play:

Bank One

(ONE) - Get Report

, down from a year high of 63 9/16 to 33 7/16 Thursday. (He has no position in either stock.)

Selling Bank One stock allows an investor to take the loss against the rest of his or her winners. Thursday, for example, a big trade of January 35 call options in Bank One crossed just over 2,000 contracts at a price of 1 1/16 ($106.25), down just 1/16 ($6.25). A call option is a contract that gives the buyer the right to buy stock -- usually 100 shares -- at an agreed time and price.

Another big print crossed in

Pfizer

(PFE) - Get Report

, just over 5,000 contracts at 1 1/8 ($112.50). The stock was up 1/4 to 35; the drug company's stock has dropped from a high of 50 this year.

Meanwhile, the Christmas spirit didn't stop the speculation on the

Nasdaq

, which crossed the 4000 mark for the first time Thursday.

The

Nasdaq 100

unit trust

(QQQ) - Get Report

topped the most-active list, particularly the out-of-the-money January 172 put options, trading at 4 5/8 ($462.50), down 5/8 ($62.50).

The Nasdaq has slipped back, but was still up 58.21, at 3995.51.

But index call options were also trading heavily, hinting at big bets on continued market strength; however, the index options were deep "in the money" -- meaning below the strike price. Such bets are often viewed as proxy bets on a spike or a drop in the market. Among the most active were the

S&P 500

, or SPX, index options, in particular the January 1425 and January 1325 puts and calls. The index was trading at 1458.97, up 22.98.