With volatility expectations slipping, options prices are falling substantially. That has some traders recommending buying upside call options as a way of generating exposure to market gains.
"Often people think of options for protection on the downside, but a novel approach now is to look at options for protection to the upside," Dennis Davitt, partner at Harvest Volatility Management, said Tuesday on CNBC's "Trading Nation." "So what you can do is buy an upside call in something like the IWM, and you limit your losses to just the premium you pay for the option."
Specifically, Davitt would recommend that those interested in stocks buy something like the 120-strike call on the Russell 2000 ETF (IWM), which grants its owner exposure to any gain in the ETF above the $120 level between now and September. On Wednesday, that option would cost its buyer a little more than 1 percent of the price of the IWM, and would provide access to any gains of 6 percent or more.
While options can always be used to provide leveraged exposure to the upside or downside, options prices have gotten considerably less expensive recently to the extent that the derivatives are pricing in lower expected volatility. In fact, options prices are implying that the next few weeks will be less volatile for the IWM than the preceding ones, according to FactSet data, an unusual condition given that options prices usually overstate volatility.
The same cannot quite be said for the S&P 500 ETF (SPY) or the Nasdaq 100 ETF (QQQ), but both have seen options prices fall dramatically. In fact, implied volatility on the QQQ is the lowest it's been since before the market's August swoon.
This is probably due to a few obvious factors. Actual volatility has fallen, for starters, as has volume. And the markets have a short week ahead, which always tends to depress options prices.
Still, for those who either think stocks are set to rise, or who want to hedge any short positions, it might be high time to take a close look at bullish options on index ETFs.
"You spend 1 percent to get access and participate," Davitt pointed out.
