This Week in Finance - 8/21/08

Welcome to WallStreetOasis.com's latest This Week in Finance newsletter, where we profile the hottest investment ideas, substantive market data, incisive financial blogging, and the best under-the-radar research Wall Street has to offer.

Investments: Weighing the options

Since the credit crisis began to unfold in earnest last summer, volatility has steadily risen and has remained elevated across many asset classes. As an example (using a common benchmark for volatility), the VIX index, which measures the implied volatility of S&P 500 index options, has averaged 23 since August 2007, while averaging only 13 during the prior twenty months. The most obvious beneficiary of an environment of increasing volatility is option prices, which are largely dependent on volatility. How exactly to play options in an already volatile environment is the tricky part, and I’ll address some possibilities below.

First things first though – you need the ability to trade options before you can think of how to trade them. While most online brokerages have options trading available, and will you let you do more complex strategies, especially when phoning in the orders, there is one particular broker that stands out when it comes to derivative trading expertise and execution. Interactive Brokers has very competitive trading costs and minimums, while offering a very wide array of products and expertise, particularly in options markets. If you are serious about trading, IB is a great place to do it.

As for strategies, there’s certainly no shortage. The New York Mercantile Exchange (NYMEX), the largest commodity derivative exchange, offers a nice summary of the payoff profiles of multiple options strategies. In terms of just capturing gains from a jump in volatility (having no opinion on whether the price of the underlying will go up or down), the purest strategy is a straddle, where you buy an at-the-money call and an at-the-money put. The resulting V-shaped return profile means that if the underlying moves sharply in either direction (thus is volatile!), you make money. Of course, there are many more risks and complexities associated with trading options (too many to go into here) - the Options Clearing Corporation has an extensive document that addresses these issues.

Finally, the CBOE now offers trading in VIX futures, an easier way to play volatility than jumping through the multiple hoops required to set up successful options strategies. The exchange offers a great introduction to these products here.

Research of the Week: Don’t ignore the academics

Much of what we read today comes in an easily digestible, filtered form. Newspapers, webpages, and blogs do the work (with varying success) of taking data and research and presenting it in an easy to understand format. However, if you’re interested in more academic pieces, there is a great amount of research available through the Social Science Research Network (SSRN). SSRN.com offers users the ability to search papers by topic – you can enter in anything from “hedge funds” to “private equity,” “value stocks” to “CDOs,” and get research from all over the globe. While financial research papers are often highly mathematical, there is often a lot of useful information available outside the numbers - a quick search into any topic you are interested in or working with will certainly prove useful.

Blog-Wrap: Jobs on Wall Street, or the lack thereof

Naked Capitalism looks at the most recent trend in financial employment – specifically how the specialization of roles during the “boom” years has created great difficulty for those looking to now make a transition into other financial careers. A great point brought up here is that the allure of big payoffs often leads young professionals down this road without consideration of the future and how risky these specialized roles can be.






TWIF Notes: Struggles continue

Successful hedge funds, most notably Harbinger Capital run by Phil Falcone, are struggling this summer , as the short financials/long energy trade has reversed violently. Dan Loeb’s Third Point has also suffered from this about-face.

Insider trading maybe? Someone bought $1.7 million worth of put options on Bear Stearns, betting that the stock would fall about 50% in less than two weeks (when the options were set to expire), and made $270 million in the process.

Get Schooled.

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Questions? Comments? Send an e-mail to Hedgehog@WallStreetOasis.com or send a private message to him at WallStreetOasis.com. To read previous issues of This Week in Finance please click here: http://www.wallstreetoasis.com/xtracker/type/simplenews



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