In business, the key is not to be part of the crowd, but to know the direction of the crowd.  Don’t be a follower; try to be a leader.  If you can’t beat ‘em, DON’T join ‘em!  You should watch the crowd.  Don’t join in their herd mind-set, least you join a band of lemmings parading over a cliff.  Crowds may be right in the middle, but they’re wrong at the ends.  They buy high and sell low, the exact opposite of successful trading.

The crowd watches CNBC and so do the experts.  Go into most brokerage offices and/or trading rooms across this country and chances are they will have a TV tuned to CNBC.  Not because it’s their best source of information on the market, but because it’s their best source of info on the trading public.

CNBC only reports the news they don’t make it, or do they?  They have no bearing on prices, or do they?  Have you heard of the “CNBC Effect?”  The “CNBC Effect” takes place when the crowd reacts to the information shared with them via CNBC.  Viewers watch and listen for tidbits of information, any tip construed or otherwise, any reason to buy or sell.

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If you watched long enough, you’ve seen a CEO give a stellar interview.  Soon on the streaming ticker tape flowing across the bottom of the screen, you see the stock increase in frequency and price.  Or you might have seen a CFO stutter when asked about future earnings or worse still, accounting irregularities.  Shortly there after that stock may trade much lower in price on higher volume.

Can option traders use CNBC to their advantage?  The answer is yes!  But you need the big picture.  Some of the details may seem old hat or trivial.  When finished looping off in opposite directions, it ties nice and neatly into a bow.

Stocks are one-dimensional; price.  Options have many components: price, time and potential.  Compared to potential, price and time are easy math. Potential is a difficult concept to understand.  (Older Options 101 columns go into option pricing in greater detail.)

Volatility measures potential.  Higher potential moves in either direction produce higher Volatility.  Higher Volatility equals higher option prices.  Higher option prices mean higher potential moves, or so the formula says.  In actuality, higher option prices indicate higher Implied Volatility, but not greater potential.

Volatility comes in four different flavors.  Implied Volatility gives novice option traders a sour taste.  Another way to look at Implied Volatility is to consider it as supply and demand.  More buyers, Implied Volatility increases.  Fewer buyers and/or more sellers, Implied Volatility drops.  True potential has nothing to do with it.  There is a skew between actual and assumed probabilities, a mathematical edge. 

Option traders don’t need stock prices to move if they have correctly bet on option pricing components.  The “CNBC Effect” can and does often change Implied Volatility without ever changing stock prices.  Do not assume the additional exposure of stocks featured on CNBC will increase their Implied Volatility!  But don’t be surprised if it happens.

Being aware of the trading environment transforms option trading from betting to investing.  Anticipating future changes based on previous tendencies increases profitability.  Knowing what to expect and not being blind-sided decreases losses.  Avoiding crowds help avoid stampede disease, being trampled.

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