Investors Remain Unconvinced the Trend is Changing

Investor sentiment is unpredictable and moody. However, options traders have tools to take advantage of unusual changes in sentiment unlike any other market.

This unpredictability is definitely in evidence today as the summer vacation season ended with a roar. The Dow Jones Industrial index popped up over 200 points at the open but savvy traders remain unconvinced that the rally is durable in the near term.

This is a message you may hear from a number of analysts and managers over the next couple of days. Today is a good case-study or example of two factors in the intermarket environment that is pushing trader sentiment to be more undecided than the stock indexes may otherwise indicate. This will have an impact on options pricing and performance (here's a link for more info about pricing and performance).

1. The VIX is up while the market is up. The VIX is a measure of investor fear and usually moves the opposite direction to the indexes. What this means is that investor fear is rising while market prices are going up. That is a classic signal of a lack of confidence and an unstable trend.

The CBOE Volatility Index

2. Government bond yields are falling which will usually follow equity prices. In this case, yields are falling because bond prices are rising. That is typically a reaction to a down day in the market not a positive day. Bond yields normally fall when traders move capital into safer investments from riskier ones like stocks and drive bond prices up.

The 10-year Note Yield Index

There are a few ways to handle these risks or opportunities in the market. As an options trader you could buy puts to protect against a decline in your long stock positions. A rising VIX indicates that option prices are also rising so this trade will be more expensive but this is not a bad way to offset some risk. Alternatively, many traders are not aware that they can actually buy options on the VIX or the TNX (10-year bond index itself) indexes themselves as a way to speculate on a correction or continuation of the trend. A sharp correction on these indexes could turn into solid profits very quickly.

Bottom line: When the market is sending conflicting signals it is good to stay diversified and to explore as many trading alternatives as possible.

Ryan Teeples is a co-founder of LearningMarkets.com and ProfitingWithForex.com. His articles are regularly featured on online investing publications across the web.