by Tyler Craig | May 11, 2012 7:30 am
The market movements of the past three trading sessions have been like a freshly caught fish flopping around on a boat deck.
Bearish price moves have given way to bullish action, which has quickly morphed into bearish patterns. If the past week is any indication of what’s to come, we may be in for a choppy summer. Of course, the bulls are holding out hope that the recent correction is setting the stage for a new leg higher. But so far, “sell in May and go away” is looking like sage advice.
In times like these, credit spreads become increasingly alluring strategies. They offer the ability to establish a semi-directional bet that gives the market a wide berth to flop around as much as needed. Suppose you’ve set up shop in the bear camp and feel the path of least resistance for the next month is sideways to down. Rather than loading the boat with long put options and running the risk of getting whipsawed out of your position if the choppy conditions persist, how about selling an out-of-the-money call spread such as the July 143-148?
Entering the position consists of selling to open the July 143 call while selling to open the July 148 call. Currently the spread can be sold for $.80, which provides a potential reward of $80 and a maximum risk of $420. Think of it as a bet that the SPY fails to rise to $143 over the next month.
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If, on the other hand, you think the market correction is close to termination, you may opt instead for selling out-of-the-money put spreads. Currently the July 127-122 put spread can be sold for $.72, which provides a potential reward of $72 and a maximum risk of $428.
Entering the position consists of selling to open the July 127 put while buying to open the July 122. Consider this position a bet that the SPY fails to drop below $127 by July.
Whether the market eventually resolves itself to the upside or downside remains to be seen. As long as the price action mimics a fish out of water, though, credit spreads appear to be a much easier play than buying directional calls or puts.
At the time of this writing Tyler Craig had no positions on SPY.Chart Source: MachTrader
Source URL: http://investorplace.com/2012/05/rise-above-the-chop-with-credit-spreads/
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