Barron's The Striking Price: High Anxiety: After Put-buying Frenzy, How To...

What's worse: undergoing root canal treatment, or sitting in the
periodontist's waiting room and listening to the groans of the patient ahead of
you? That's essentially the question options watchers were asking last week as
they tried to determine just how much of the recent stock-selling is caused by
pain -- and how much is just anticipation of pain.

Certainly, there's no shortage of uncertainty about possible future pain.
Among the worries: surging oil prices,higher interest rates and continued
violence in Iraq. So it's no surprise that volatility is high.
The Chicago Board Options Exchange volatility index, or VIX, moved to the top
of its one-year range when it shot above 20 early last week. This popular "fear
gauge" ended the week at 18.86. Although it might not be evident in the VIX,
some options watchers contend most interest-rate worries and macro fears are
priced into the market at this point, and it may be a good time to sell options.
"Beneath the surface, there is quite a bit of fear built into the market,"
says Mika Toikka, global head of equity derivatives strategy at Credit Suisse
First Boston. Looking at index options prices to measure just how nervous the
market is, Toikka says implied "correlation" -- or the projected tendency of
stocks to move as a pack -- is at historically high levels. In other words, the
options market anticipates that there will be a succession of macro threats that
can force stocks to huddle in a herd.
Investors scrambling for downside protection over the last few months have bid
up prices on put contracts on the major indices -- not unlike the latest Picasso
auction. The buying frenzy has left put prices, relative to calls, at
historically high levels, Toikka says.
For investors who think that much of the selling is done, he recommends
selling short-dated index options in order to take advantage of the likelihood
that interest-rate fears will begin to subside and the market will trade within
a range this summer.

Skip Becker, president of HP Becker, kindly reminds us that there are two
sides to every trade, and sometimes it pays to zig while everyone zags. Rather
than buying puts to protect stocks he holds amid the market downdraft, Becker
has been selling out-of-the-money puts on stocks he wants to own but at lower
prices.
"Now is a time, we think, to start putting [cash] into the market," Becker
says. "If you think stocks are going to go down, why sit back and wait? Be
aggressive . . . sell premium to purchase stocks at a discount to already
depressed prices," he suggests. If stocks don't fall further, Becker gets to
pocket the put premium every few months and repeat the trade. Importantly, when
Becker sells a put he sets aside enough money to pay for the stock in case the
option is put to him.
Take Morgan Stanley. The white-shoe investment bank has seen its stock fall
from 62 in early March to the low 50s, about a 20% haircut. Becker argues that
financial stocks have mostly corrected, so he has been selling July 50 puts on
Morgan Stanley, which were recently trading at about $1.70, and setting aside
$50 a share in case he's forced to buy the stock.
If Morgan Stanley shares stay above $50, then Becker gets to pocket the put
premium earned. Hypothetically, he could repeat this trade six times a year and
collect more than $10 in premiums. That's a 20% return on the $50 earmarked at
the outset for this trade.
If the stock drops below 50 before the sold puts expire, he's faced with the
choice of buying the stock or buying back the put to close the position. Let's
say he chooses to buy the stock. His cost in July is $48.30 a share ($50 less
the $1.70) or a 7% discount to Friday's closing price of $52.08. "The key is, I
am doing it on stocks I want to own and am willing to own at a discount to
today's market" he says.
One risk, of course, is that Morgan Stanley shares rally sharply and Becker
misses out on an opportunity to own the stock, but he argues that's unlikely in
the current market.
He also tries to mitigate his risks by using this options strategy on 15 to 20
stocks he likes: "It's a way to utilize cash and not just earn 1% in a
money-market account," and to "build a new portfolio at 8% to 15% below today's
prices."

Meanwhile, the Nasdaq Composite index hit its lowest level of the year last
week despite solid earnings from tech bellwether Cisco Systems and others.
Traders noted heavy selling of May calls on technology stocks, including
Qualcomm, Intel and Cisco. In the Nasdaq 100 Tracking Stock, or QQQ, investors
were selling May 35 calls. These call sellers are taking in premium and willing
to forfeit gains, should the QQQ rally this week. In other words, some are
bracing for further weakness in the market through May 21, when May options
expire.
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