Option Investor


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Good Morning Troops,

By now many of you are probably aware of the world-wide equity sell-off. That's the nice way of saying it. The not-so-nice way of saying it is that the market is going into the toilet this morning. How far remains to be seen.

It's about 5 a.m. ET as I write this and the S&P futures are down about 63 points -- which, if they remains at this level, means the S&P 500 will open between 1255 and 1260. It won't be pretty. The DOW is down over 500 points. Somebody yelled "fire" in the theater and there is only one exit.

So, the $64,000 question is -- how do we handle it? Will we join Chicken Little in yelling that the sky is falling and run, or will we be patient?

Our lone February (let's be thankful) is the SPX 1300/1290 bull put spread. A few things will likely happen.

1. If the futures are an accurate indicator, the market will open and our position will be 50 points in the money.
2. Volatility will go through the roof -- possibly reaching the mid-30s level (on the VIX) that we experienced in August.
3. The bid ask spreads on the SPX options will probably be anywhere from $2.50 to $5.00. Meaning that it will be extremely difficult to negotiate and calculate exits for old positions and entries for new position.

It's going to be ugly. I heard the talking heads say there's a possibility of the Fed making a rate cut before the open, but don't hold your breath. It will probably come in the next few days, but when? Your guess is as good as mine.

In these sharp sell-offs, we can expect a bounce - today or tomorrow. Everything will get hammered, even the best companies -- and the bargain hunters will be out in force. Institutions are sitting on a lot of cash and, hopefully, they will put some of the cash to work when valuations become attractive. Then, add the looming rate cut and the bounce could be substantial -- maybe.

Considering the fact that our position will be so far in the money, there's no point (IMHO) in trying to salvage a buck or two. I will opt to let the hand play itself out a bit further and let the smoke clear before taking any action. The only positive, at this point, is that we have a full month until expiration. That should give us plenty of time to evaluate the situation and to potentially roll out to another month and give the market more of a chance to heal.

Now, it's possible that you may be able to close the current position and salvage that dollar or two. The market makers will be going through the same chaos that we will -- and they will be looking out for themselves big time. If they let you out at all, it will be on their terms.

This won't be easy to watch, but that's what I'm going to do -- just watch. You may choose to toss out an order here and there. I haven't experienced this large of a sell-off before with an open position. But, we're going to do the best we can -- trying to take emotion out of the equation (if possible).

I should be around all day if you want to talk. My 400-plus seminar grads have my personal email and phone number. Don't hesitate to contact me. As always, I'm here for you. CPTI subscribers will go through the normal channels (support@optioninvestor.com or mparnos@optioninvestor.com) and I'll get your emails sometime later in the day. I will try to respond as soon as I can.

What is actually sort of appealing is the idea of, when the market tanks, to try and sell another bull put spread about 125-150 points further out of the money. I'm glad we kept our powder dry.

Hang in there and be glad you aren't over-leveraged. This kind of situation is one of the reasons I don't encourage arbitrarily increasing contract sizes after a bunch of successful months.

Good luck and keep the Pepto-Bismol handy. Things might change before the open, but this is how things look at this point in time.


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