Most novice traders don't realize that they are buying in a top and selling in a bottom.
I like thinkorswim. A lot. It’s a great trading desk for both individual and institutional traders alike. I've never met Tom Sosnoff, the man who started the firm, but I still read his blogs over at Tasty Trade.
Sosnoff wasn't around to comment this morning, pre-market, so he had Tom Preston write the morning's "Cherry Bomb". It was short and not very sweet.
For those that couldn't care less about the market or it’s dynamics, this short quote may not make much sense. However, you should still be listening and you'll see it's not just me that sees the writing on the wall.
I read an article by a financial media bigwig that said the current VIX at 12 was a good thing because low volatility might encourage what the author described as "the little guy" to start buying stocks again. Now. With markets near all-time highs. Ugh.
Let's put a little of the market's perspective on that advice. In SPX August options, the 1805 puts and 2010 calls are both worth about $5.00. A way to interpret this is that the market is pricing the possibility of dropping 7.9% the same as rising 2.6%. That's a 3:1 ratio of downside to upside. So, if there are any "little guys" reading this, realize that the limited upside you get from a low VIX is hardly worth the risk when the market decides to pay the downside.
To interpret, Preston has noted the cost to purchase the product that is geared towards a drop in the market (a Put option) is priced to reflect the expected drop in the market. When this happens, you can not only bet the market will respond, you can guarantee it. Here’s why.
Prices are generally dictated by market makers. These are traders that purchase stock from you and those that sell it to you. In other words, if the market makers have it priced that way, you can darn well bet that they will corral you into buying what they’re selling and vice versa so that they can gain an edge.
Jumping Too Late
Because most Americans LOVE a winner, we'll naturally love a bull market. We just can't help it, hoping to ride the wave higher. Because the market continues to move up, most novice traders don't realize that they are participating in a top.
The proof in the pudding is when people who have never traded before jump in, hoping to score a win. They'll buy at any cost. And guess what? This is when they are crushed, because they jumped too late, catching the last remnants of a bull market, when every man and his dog are drooling with excitement.
It's the worst idea ever.
... and the market makers are going to sell you the dud. I too will sell it to you, and you will lose. The option markets are a zero sum game. Somebody wins and somebody loses. I pray it's not me.
As Terence Stamp says in the great movie, The Limey:
Tell them I'm coming.
It's a fantastic, creepy moment and one you should be prepared for, because he was coming for the kill.
So, to summarize, if you're trading the markets, watch out. I don't care if it goes up today. And tomorrow. And the next day. Nobody can predict an exact date, but when the current market conditions are priced to expect a 7.9% drop, that's a TON of weight to not step out under.