If Option Volume is up what does that mean for trading the stock market, commodity market, forex market (July 24, 2008)

If option trading volume is up what does that mean for the stock market, the forex market, and commodity markets, as well as the options "market". This question was asked and the article below was referred to us.

One has first to distinquish between option volume on a given stock, and volume on the stock market as a whole. For a given stock, it could mean something (and even nothing) but one cannot tell whether it is for upside or downside speculation (or even no specualtion at all). For the general case, the complete answer is it depends, but the common reasons are below.

Take the case of the stock market as a whole, this typically happens when the market is rolling down. Some may say that the answer to the above question is that market participants are nervous, but in reality the answer is rather something else. Nervous people who are long the stock market typically go to cash or ride the storm. The others can be divided in various groups. One should note that the typical average retail trader does not have accounts where s/he can short stocks, so they typicall buy puts. These traders place bets on the short side by buying put. There are also those people who simply try to use option leverage with the thinking to break even, when they have losses, bu buying calls (which may translate to buying puts for the professionals who sell these calls).

Those who produce options for these buyers are experienced traders, and are in a finite numbers, and risk size. When this happens, option premium rises. Because of put hedging by the professionals, an increase in short selling of stocks or shorting of futures takes place. This causes the market to move increasingly faster on the way down, and at the same time it can lead to the average speculator to buy even more premimum. This process continues until it reaches a climax when there has been a maximum number of option buyers, the market bottoms, a sudden sharp rally makes the buyers of put premimum lose. The whole market goes back to normal after the typical sharp rally that cleans those who should not be there in the first place.

NOT NOT FORGET TO CONSIDER ENROLLING (please state if you have particula interest in a given market (options, forex, stocks, futures, retirement investing/income, etc)

Here the article from bloomberg:


While few, if any, investors are making money buying U.S. stocks this year, the market for puts and calls is providing a bonanza on Wall Street where options trading has never been so brisk....

....last week was the busiest ever for options trading, with 93.8 million contracts changing hands, according to Chicago-based Options Clearing Corp. The almost $100 billion in bank subprime mortgage losses that sparked the worst yearly start to stock trading since 1982 is also boosting volatility. Wider price swings increase the likelihood a contract can be exercised; when volatility rises, so does the price of an option.

``The options market thrives on fear,'' said Chip Hendon, who helps manage $12 billion at Huntington Asset Management in Cincinnati, including $150 million in listed options. ``When there's more fear, there's more opportunity.''

The Standard & Poor's 500 Index last week posted its third straight weekly loss, declining 0.8 percent. Europe's Dow Jones Stoxx 600 Index retreated a fifth week, slipping 2.4 percent, while the MSCI Asia Pacific Index fell 2.8 percent.

Betting on stock declines isn't making investors as much as buying contracts in the $1.3 trillion U.S. options market.

Investors who bought a contract to sell the S&P 500 for 1,460 by the end of this week have doubled their investment since purchasing it at the start of the year. Shorting the index, or selling a borrowed security in the hopes of replacing it at a lower cost, would have returned 77 percent in the same period.

Options on the S&P 500 are 24 percent cheaper than in November, according to the Chicago Board Options Exchange Volatility Index, even though stocks are lower. Goldman Sachs Group Inc., the most profitable securities firm, and New York- based BlackRock Inc., the second-biggest publicly traded U.S. asset manager, say volatility will rise this year.

Last year's increase in swings set a record, when the volume for contracts on shares, exchange-traded funds and equity indexes grew 41 percent to 2.86 billion, according to the OCC....

``You'll see more and more mainstream funds asking their boards for permission to use options,'' said Quincy Krosby, who helps manage $330 billion as chief investment strategist at Hartford Financial Services Group Inc. in Hartford, Connecticut. ``It's becoming easier to do, less expensive and in markets that are more volatile and can change radically in one day, it may also be the prudent thing to do.''....

``It's a recipe for volatility,'' said Dean Junkans, who oversees $260 billion as chief investment officer at Wells Fargo & Co.'s wealth-management division in Minneapolis. The firm almost doubled the use of options for its clients last year, he said....

Maneesh Deshpande at New York-based Lehman Brothers Holdings Inc. and Goldman's Maria Grant say volatility will stay high. The strategists -- heads of the top-ranked derivatives teams in Institutional Investor magazine's 2007 survey -- recommend buying puts on the S&P 500. Grant favors those that can be exercised if the benchmark falls 3 percent to 5 percent by Feb. 15.

``Volatility is here to stay for the next few months,'' said Craig Effron, who oversees $3.5 billion, including options, as co-founder of Scoggin Capital Management in New York. ``A lot of people have recession fears, and they think the market may fall apart.''