Legg Mason: Our managers on the markets

The third quarter of 2008 will be remembered as one that forever
altered the landscape of the U.S. financial system — through the
nationalization of Fannie Mae and Freddie Mac, the seizure of AIG
by the federal government, the conversion of Goldman Sachs and
Morgan Stanley into bank holding companies, and the downfalls
of Lehman Brothers, Washington Mutual and Wachovia. All of
these events were consequences of the bursting of the massive
credit bubble in the U.S. banking system and the spillover from the
significant slowdown in housing that escalated last year.

In these uncertain times, we believe that the insights of industry
veterans who have seen the ups and downs of multiple market
cycles can provide valuable perspective, as we seek to understand
the complex issues facing the economy and capital markets. In this
issue of Briefly Speaking, key portfolio managers and investment
strategists of Legg Mason’s affiliated investment managers offer their
perspective on these unprecedented events, views on the markets,
and strategies for managing assets in their specific area of expertise.

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Market Volatility Presents Advantage for Options Investing

There are all sorts of records being set on Wall Street this week. It is a sign of a panic-stricken market filled with investor anxiety and an incredible flight to safety.

Some of the records, like the amount of companies hitting all-time lows, are quite scary and offer little in the way of optimism. But other records are well worth watching. They are pointing at some pretty interesting and lucrative investing opportunities.

First, take a look at the action in the options market yesterday. The Chicago Board Options Exchange (CBOE) reported a new high in trading volume of S&P 500 (SPX) options. Nearly 2.2 million contracts traded in yesterday’s frenetic market. On the average day, just 670,000 options change hands.

More importantly, yesterday will go down as the third busiest day in the options-trading market’s history. Over 9.5 million contracts were traded.

When so many options get tossed around, it is a surefire sign of one thing, volatility. And as you guessed, the CBOE Volatility Index (VIX) saw record levels as well. The index stretched out to reach a reading of 58.24.

When markets are trading in a normal fashion, the index is somewhere in the range of 15, with a reading of 20 a rare occurrence. This week’s scores above 50 are a sure sign of trouble in the markets.

All of these newly minted records tell a pretty important story. When markets are raging back and forth, options investors have an incredible shot at profits. As long as they can keep their eyes and ears focused on the markets (I have been watching the action from 6:00 a.m. until at least 9:00 p.m. during the past few crazy weeks) and are prepared to move quickly, there is enormous potential.

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