Index Options versus Stock Options: Why I Prefer Stock Options

In our electronic mutual fund world, it seems only logical to trade index options instead of stock options.  I honestly think some people believe that they have some kind of diversification that really does not exist. 

When I trade options that are highly volatile and close to the expiration, I closely watch the Dow and the S&P 500.  It is the movement of 30 stocks that moves the Dow, as we all know.  And - of course - it is the movement of 500 stocks that moves the S&P 500.  Often the “broader markets”, as your tv commentators will call them, effectively MOVE stocks you are active in.  If you are not watching the Dow, you should not be day trading.  You have to see that the broader market is starting to tank.  This tells you to close out a shaky position and wait for an upswing.  It starts to move up, and  you know that your position is likely not going to be pulled down by external forces.

Now, what are you supposed to look at while trading index options?  Other indexes?  Which ones?  Are you supposed to keep your eye on all stocks included in that index?  And if one starts to tank, you are already affected as this is not a lagging effect. It is immediate.  If you are doing options and you are watching the broader markets, you can get a cue quite easily and you will have time - in most cases - to protect.  Sometimes it is just pulling back an order.  That lag time between the index and stocks outside of the index is more than enough time if you are watching what you are doing.

I stay away from index options because I see a huge potential to make money because the broader market gives you a clue. 

Look at this:

Google is not a Dow stock, but you can see how closely if follows.  You will note that when the Dow changes direction, GOOG follows shortly after that.  Traders are watching - and making huge decisions once they see the market move.   

You would be a fool to not watch the Dow if you are playing Google.  When you see the Dow start to slip, you pull back from risky orders.  If you see the down reverse course, you can be more comfortable that Google will. 

Check out stocks you like historically for how they compare to indexes they are NOT a component of.  You are benefiting from the lag that traders watching the entire market see.

This extreme volitility has created some great option plays for the next month.  I am going to be looking at a couple of sectors.

 First, MER and LEH are still great shorts.    I think each will see $30 soon… at least for enough time to cover a short position.  Both are trading at about the same level.  Cramer may tell you different, but I would not listen to him on the financial sector.  They are his buds.

TECH… CSCO still has a huge intermediate and long term story.  If you just want to put some money is a solid company, this may be the one.  AAPL I think is going to rise soon.  You need to buy only at the low right now, as it does have a downside.  Look at a couple of trading days and try to buy near the lowest point.  Do not over pay. 

GOOG - I should disclose I have a few 440 March Calls.  Let’s hope I can catch up to even on those before the market close tomorrow!  I see the stock as unsettled right now. I am playing both sides of the fence here.  I think we will see $390 before we will see $490 again.  I am seriously looking for low priced April and June Puts in the near future.  Lowe priced, but achievable. 

SIRI / XMSR - Forget about them.  I do not think the deal will happen.  I see no great action here.

YHOO - Something is going to happen within a week or two that is likely to move this up or down sharply.  I think up, as I do not see MSFT lowering its offer.  YHOO is showing great value.

 MSO - Still a short. See my most resent post on it.

I have been trying to identify the next Bear Sterns.  Fortunently for all of us, I have not found it. I am seeing all of the stories on Merrill Lynch

 Merrill riskiest after Bear Stearns, says Wachovia
Reuters(Tue 9:45am)

Merrill Lynch riskier than Lehman, analyst says
at MarketWatch(Tue 9:12am)

 I am seeing it up sharply despite that news.  I am doing the APR 35 PUT.  It is very risky in that the stock has not traded in that range in YEARS.  However, I think it is a great play for a few days.  When the market dips, I think MER will be going back with it.

 Good luck to all!