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About SENTIMENT

Welcome to the sixth issue of SENTIMENT, smart options for today's investor. We're calling this our "Volatility Issue," because volatility is certainly shaping up as one of the dominant themes of 2010. Witness what we've experienced thus far: an April peak, a May flash crash, a June swoon, and a July rally. To that end, we are offering readers a special package of articles on volatility, including a primer on why this subject is so important for options traders, some suggested strategies for profiting during periods of high volatility, and a look at some volatility tools to help you determine whether the options you are buying are "cheap" or "expensive." SENTIMENT is for options traders and those interested in learning about this growing corner of the investing world. We hope that you will find the articles in this issue timely and insightful, and that they will help make your trading more profitable and more enjoyable. Along with SENTIMENT magazine, Schaeffer’s Investment Research Inc. offers a full array of print and multi-media educational offerings to the options trading community, including the Option Advisor newsletter and our award-winning website, SchaeffersResearch.com. If you like what you see in SENTIMENT, please visit our website to see more, and don’t forget to check out our archived issues below.

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If you know anything at all about Bernie Schaeffer and Schaeffer's Investment Research, it's probably that we're contrarians. What does that mean in terms of market analysis? In this piece, Bernie revisits Humphrey Neill’s iconic The Art of Contrary Thinking and some of its most famous dictums, including that the crowd is right during the trend, but wrong at both ends. Bernie concludes that the rules haven’t changed much in the decades since the book was published, but the investment landscape sure has.

There’s little doubt that the volatility landscape has changed dramatically in recent years. On a daily basis, in the four years ended December 2007, the CBOE Volatility Index (VIX) -- which tracks volatility on the S&P 500 Index -- averaged less than 15. However, from early 2008 through mid-June 2010, the volatility index produced an average reading of around 30, or more than double the levels seen the four years before. If volatility has you confused about options, it's time to get back to basics. Ophir Gottlieb and Kevin Lund hold the keys that unlock the door to options enlightenment.

The rise in the VIX since 2007 reflects the bigger daily price swings seen in the equity market—which has also resulted in richer premiums across the options market. Essentially, as market volatility has gone up, so has the demand for options. How should investors operate when the risks of speculating with long options are high, and the cost of portfolio protection has become high, too? Is it smart to buy and hold stocks with no hedge at all? Or, is it worth paying a higher premium to hedge market risks? Fortunately, there are ways to navigate these uncertain markets using options. This article by Frederic Ruffy and Andrea Kramer looks at two very attractive strategies for this environment: the ratio backspread and the calendar strangle.

The bleak performance of large-cap stocks over the past 10 years has led many pundits to rethink traditional buy-and-hold investing strategies. However, many of these same experts have overlooked the outperformance of the Russell 2000 Index (RUT), which tracks a basket of smaller-cap stocks. Just like blue chips have—or had—a reputation for being "safe," smaller caps have a reputation for being risky. However, as Todd Salamone and Elizabeth Harrow report in The Sentiment Report, during the so-called "Lost Decade" -- while the S&P 500 Index lost roughly 24% of its value, and the Dow Jones Industrial Average shed more than 9% -- the RUT rallied nearly 24%.

Regular features in every issue of SENTIMENT include The Sentiment Report, a quarterly market roundup; the Idea Lab, an examination of technical analysis tools; Ask Bernie, with Bernie Schaeffer answering some of the most commonly posed questions by traders; and .COM, featuring the "best of" recent commentaries and blog posts on SchaeffersResearch.com.