Papale’s Market Pep Talk

Happy 2013.  It is just a few days into the new year and I was strolling through the internet and saw a few predictions for the upcoming year.  With higher production and refining capabilities many are saying the price of gas will start a long and gradual downward move.  I like that one.  Bill Gates will come out of retirement and take over at Microsoft again.  Must be bored.  The New York Jets will be sold to Mark Cuban.  Eventually he will own a team from every sport on earth.  And finally, sink holes will form around the world causing unpleasant odors to permeate into the atmosphere.  I have some of this around my house already.

We made it through the fiscal cliff, at least for now.  Markets liked what they got and rallied hard the last two days.  With the news of the deal and the ensuing market rally, the VIX has dropped from around 22 to 14.  Not unexpected.  For those with positions, especially out of the money calls, you may be watching the market rally like crazy and see the calls barely move.  Remember, there are three forces working on the value of the options – time decay, volatility and movement in the underlying.  The market has moved up significantly over the last days.  However, drop in implied volatility has taken much out of the extrinsic value portion of the option.  And if the option is out of the money, this take away can offset any increase that may have occurred due to movement in underlying.  In addition, theta is always working and if you have January options this can really start to accelerate as we get toward the end of the month.  If you are frustrated that you picked direction correctly but your options have not paid off they way you would have liked keep in mind the three forces that drive the price of the options.

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