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Options Signal More Volatility Ahead

The options market is signaling that the stock market is in for more volatility ahead, according to an options expert.

"In general, I think that the financial sector is a fiery furnace of implied volatility today. Yesterday, as of the close, we saw gains in implied volatility of at least 50 percent in most major financial names," Rebecca Darst of Interactive Brokers said on CNBC early Tuesday. "And here, there was no distinction between broker-dealers and depository banks, gains in implied volatility of at least 50 percent, and in most of these cases, this means that the implied volatility reading is now at record highs, well above the highs reached previously in mid-July."

"When you talk about the measure of implied volatility: Option contracts are like insurance that you take out on a stock price, and when a stock is perceived to be very volatile, or there is perception among option traders, or in the options market, that a stock is going to be very volatile, it drives the price of that insurance higher, which means the implied volatility reading goes higher. You'll see an implied volatility reading go up before an earnings report; you'll see implied volatility go up before a merger announcement; in this case, we're seeing implied volatility go up because people are buying protection against the financials, because there's a great deal of uncertainty." (See her full comments in the video)

On Monday global markets dropped significantly following news that Lehman Brothers was filing for bankruptcy protection and Merrill Lynch was merging with Bank of America . A disappointing earnings report from Goldman Sachs is adding to concerns.

"There is a widespread concern about volatility in both the money-center banks and in the brokerages, and in most cases, just to give you a sense of the kind of risk premium that's being priced into the options on these institutions, in most cases the implied volatility reading is at least twice the historic reading on the stock, and in some cases, it's even more. In the case of AIG , for example, the implied volatility is up at three times the historic reading, just to give you an idea of the kind of fluctuation to the up or the downside that a stock is going to experience."

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