By J Hamon

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Talented traders have lost years of profits in one unplanned moment, when an unexpected war occurred or the stock market crashed. Unbelievably, events like these affect other seemingly unrelated markets. For example, option volatility in cattle almost doubled in one day when the stock market crashed in 1987. These seem like two totally unconnected events, but the realities of the market react quite differently. For example, our plan of using “Neutral Positions” to sell options (selling an out-of-the-money put and call), calls for us to close out or adjust the position to maintain the original balance if it exceeds our expected trading range on either side of the market, or if the price of either option that we sold doubled.

He analyzes option volatility levels, the technical pattern of the market, the trend of the market, and the market’s current reaction to fundamental news to determine whether volatility is high, low or there are disparities in option premium. He then decides the best trading strategy to take advantage of both the volatility levels and the technical pattern and plans his trade accordingly. IF THERE IS NO SIGNIFICANT ADVANTAGE OR TRADING OPPORTUNITY, HE WILL STAND ASIDE. He knows there will be other days and other markets that will provide “better playing hands” for him.

4. Some general rules that are prevalent in option skewing include: 1. Volatile markets exhibit greater skewing in out-of-the-money options. 2. Calls almost always have a greater increase in the “skewing effect” than puts. It is our view this occurs because of small traders demand for call options in bullish markets. Most traders prefer to be “long a market” rather than short based on the psychological assumption that a market can move to infinity and an unlimited amount of money can be made; while prices can only drop to zero thereby “limiting” potential profits.

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