Is Volatility Over Priced?

We’ve seen this movie before. Different actors. Different setting. But it’s the same old formulaic screen play. … And we know how it ends.

Every so often, a controlled problem arises that leads to opportunities in the market. Like, remember the Y2K bug panic in December of 1999?  Panicked investors where buying up options to protect against the virtual end of the world (or end of the virtual world), driving volatility sky high. The smart-money traders (i.e., the traders who did not panic) were the ones selling the insurance to the traders who were freaking out.

Now we have a partial government shut down issue and we see the VIX and vols on individual names rising up, up and away.  Granted, the longer the government is shut down, it will have continued adverse effects on the U.S. economy.  And, perhaps the sell-off in the market is somewhat warranted, but at some point, our public servants (Wait. Public Servants? Did I actually say that?) will reach a deal.  And though it will likely leave somewhat of a scar on stock prices, we’ll see IVs fall and come back into line.

What’s that mean to your trading? In my opinion, it’s time for some selective option selling. When implied volatility is high, that means options are expensive and, arguably, over priced. We have a good idea what the effect will be on stocks. It’s a directional issue, not a volatility issue. Vol is high right now and I think options are ripe for selling.