Brexit Provides a Review of Pitfalls for Options and Futures Traders

As news poured in regarding the outcome of the Brexit Vote it became increasingly clear that Great Britain had voted out. Markets reacted as Futures Markets often do in adverse times: extreme volatility. The E-mini S&P traded at an intra-day session low, the permissible limit at the time, of 1999. Gold rallied to a high 1362.60 and the currency markets had tremendous volatility which was led by the British Pound which fell by more than 10% from the session high.

This type of volatility shows just how markets can get caught up in the frenzy of news. The lessons to be learned are significant. The Chart below shows 10 days’ worth of price movements for the British Pound and the E-mini S&P. Brexit led market news for many days before the vote and dominated world trading both before and after the tally. Unfortunately, while the Pound was rallying the E-mini S&P was mirroring its action. Almost everyone was taken in by the idea that Brexit would be voted down. Currency trading and bookmakers set the trend that despite the polls, which indicated it was too close to call, the Brexit vote appeared to be a done deal. I have never seen trading action that so inaccurately predicted the outcome of an event. Currencies, stocks and bookies were all strong indicators of the fall of Brexit; they just didn’t predict the vote of the electorate.

 

While the British Pound and the E-mini S&P settled above their lows, the E-minis looked particularly soft at sessions end. Implied Volatility rose significantly and any gains for the year were wiped out in a fell swoop. The main question is will Brexit have the impact on the American economy that was indicated in the market today? It may be that just as the market over-reacted on the upside before the vote its sell-off was beyond what is an appropriate reaction. It is likely we will find out sooner rather than later.

Here are some things lessons that events like Brexit can help reinforce:

1)      Stocks are commodities and trade like Futures Contracts. The S&P’s rally and overbought status in the last week or so contributed significantly to the volatile atmosphere of the markets after the vote. While the high and low of Friday’s session were also the high and low of the last ten days, the E-minis managed to settle just above the 200 Day Moving Avg.

2)      As markets move, shedding Deltas is a good idea. Since markets tend to revert to the mean, if you are fortunate enough to catch a move, more often than not it makes sense to lighten up on a position and take profits. (Frequently traders are reluctant to do so because of commissions and the greed factor.)

3)      Even the trading in Gold on Friday was a good example for staying away from a market. Joining the trend, such as in Friday’s Gold move, could have been very costly since although Gold was up significantly, it closed at the end of the day more than $40 from its intra-day high.

4)      While the Futures Markets are often open overnight, the availability and liquidity of options trading is typically inadequate.

5)      For those that trade Options Contracts, the illiquidity that occurs during times of market frenzy can cause a trader significant disappointment however, the ability for Options Trading Strategies that are most interesting is most often available in high volatility situations.

One way to participate in market moves with minimal risk is with Options Spreads. If you have a desire to learn about and trade options contracts, our Individual Options Training Webinars are designed to provide you with an understanding about the necessary topics for an Informed Option Trader.

 

Options trading involves significant risk and is not suitable for every investor. The information is obtained from sources believed to be reliable, but is in no way guaranteed. Past results are not indicative of future results. 

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