Saturday, July 19, 2008

When the VIX is high so is the premium

When the vix is high the premium of stock options tends to be much higher as well. It is important to understand this concept.

What does that really mean? When you buy a call you pay the difference between the stock price and the strike price of the option you bought. You also pay an added fee made up of factors like time decay and volatility. All these factors are figured into the price of a given option.

When the VIX goes up it signals volatility is rising. This means so is the premium of the options that you are paying for. Which also means that if volatility goes down so will the price of your option.

So, what can you do when volatility is high in the market? There are a couple different answers to this question. The first and most obvious is selling options to collect the premium. If you sell options using the covered calls or a spreads you can take advantage of the higher prices of options.

But selling options can only give you a limited return on your money. If you like buying options because they give you an unlimited reward potential you may want to simply buy stocks. Stocks will not move as fast as the options will but they will give you a potential return that has no cap on it.

Still, you can buy basic calls and puts during this time. Many traders don’t care too much about rising volatility. Just remember if you are buying options during highly volatile times you are taking a bigger risk then during regular times.

Every trader should make their own decisions on what to do in a situation like this one. Not all traders agree but that is how the market is set up after all.

For more information about the VIX visit

For more information about the stock market visit

No comments: