I’ve been reading The Options Bible lately, which I didn’t think I’d get much out of other than mechanics of different options strategies, which I feel pretty comfortable with already.  However, while reading the section on selling naked puts, it discusses on how you can sell PUTs as a way to mark an entry point to when you want to buy a stock, while collecting premium.  Lately, I’ve been looking at AAPL when it was in the high 90s and I was wanting to get back in if it was going to go back to 90 again, so I realized I could sell PUTs, collect the premium, and then if it does go back to 90, and if I was assigned, I would be obligated to buy the shares for $90, a price I wanted to pay for anyways.  If it never got down to 90 then the PUTs would expire worthless and I’d keep the premium I collected.

Now, when it actually gets back close to 90, I may chicken out and want to change my mind based on a different market outlook, so the only way to get out of the obligation would be to buy back the PUTs but by then they would have increased in value if the move down was quick, probably causing a net loss.  However, if I was still convinced 90 was a good price target for me then it’s a good way to commit yourself to buying at that level and collecting some premium on the way down.  Pretty cool!

I have yet to understand how an option contract can have such huge volume on such little open interest. At any rate the put action on UBS the other day was an extreme example of this. Looks like a lot of people are betting on UBS going down sometime soon.

P.S. I later learned that open interest is how many contracts had been written and were still open at the open of the market, and when there is a huge volume/open interest disparity it is a combination of those contracts being traded over and over, but, more likely, that many new contracts have been created that day after the market had opened buy new options writers (sellers of new contracts).

On Wednseday morning Lehman Bros (LEH) released quarterly earnings. There was a lot of negative sentiment against LEH going into earnings and I considered getting buying some puts on Lehman but I didn’t do it soon enough and I don’t like buying options the day before the announcement due to the risk of getting caught in a volatility crush.

Shortly after the earnings announcement in the morning, the stock was down $2.08, almost a 3% move down. However, the December front-month ATM and OTM puts, which should have gone up, actually went down in price. The reason is that once the earnings came out uncertainty went down, which decreased volatility. Volatility affects options closer to expiration . This teaches 2 things when trying to time the market with options:

1. When volatility is high (like the market is now) beware of volatility crushes like these
2. You’re more likely to be a victim of volatility crushes when playing with options close to expiration

I had been the victim of a crush in the past and didn’t know what it was and didn’t understand why when the underlying stock of my calls went up why my call options went down in volume. That’s because as a beginner I often traded front-month option near earnings. Sometimes it worked as an earnings surprise was announced, surpassing all of the volatility premium I had paid for. However, on other times what the company announced was what everybody expected, or worse, and I got caught in a crush.