Don’t let ‘em fool you — this time won’t be different and in fact, it’s a fine time to be a bear. And by positioning with vertical option spreads in the SPDR S&P 500 ETF Trust (NYSEARCA:SPY), the task of selling in May and going away is a whole lot easier of a proposition to consider.
Oh I know, with bearish overtures from the likes of Russia and Greece having seemingly disappeared from investors’ collective consciousness and replaced with razzle-dazzle earnings celebrations in the likes of Netflix, Inc. (NASDAQ:NFLX), Amazon.com, Inc. (NASDAQ:AMZN), Microsoft Corporation (NASDAQ:MSFT), Google Inc (NASDAQ:GOOGL, NASDAQ:GOOG) and others — this party in the S&P 500 is just getting started, right?
If you’re inclined to see life through those rose-colored spectacles, negative yields in Germany and a monetary match lit under the dragon’s tail of the iShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI) are additional reasons to grow even more bullish on the S&P 500, I suppose.
But if like me you’re weary of the optimism and investor behavior and see a second go at “NASDAQ 5000!” as still suspicious; then a bearish market position in the S&P 500 using SPY options makes better sense than it might have just a short time ago.
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The chart above is the daily of the S&P 500 ETF. Given the earlier hat tip to large cap tech we could easily have focused on the PowerShares QQQ Trust, Series 1 ETF (NASDAQ:QQQ), but I’m a fan of the SPY’s relative weakness in recent sessions. I also thought it important to pay tribute to Dec. 18, 2014, much like the two descending triangles shown have done.
December 18? While the Flash Crash from five years ago has been in the news as authorities have finally fingered a rogue High Frequency Trader as their scapegoat, last year there was a trading event in the S&P 500 I’ll refer to as the Cash Dash — it’s received a whole lot less finger-pointing and publicity.
I called it the Cash Dash as nobody else has bothered to give it the title credit it deserves. Yet the algo-driven buying spree was responsible for spiking the S&P 500 up a couple percent in a handful of seconds on more than $200 million in trading activity before reverting back to its prior level like nothing ever happened. Mind you, the SPY is the most liquid ETF on the planet!
Back to more traditional chart work — with the seasonally weak period of May-October upon us, it’s time for 2015 to demonstrate some weakness in the S&P 500 beginning in May.
It’s true both of the S&P 500’s descending triangles have failed to deliver on their own bearish inclinations. However, I like that the development of both patterns and that each one’s upside breakouts have been held in check by the highs set on the Cash Dash.
I see the Dec. 18 highs in the S&P 500 as a reference point for what’s wrong with the market and a price that shouldn’t be broken in the SPY. Coupled with a six-year run of more than 200% and CBOE Volatility Index (INDEXCBOE:VIX), or Fear Index, that’s much more aligned with the fear of missing out than in the fear of heights, the bears have it.
SPY Bear Call Spread
Bears also have lots of options to work with, quite literally. In the S&P 500 ETF, the SPY calls and puts are in a class all their own with penny increments, one-point strikes, weeklys and massive investor participation. Case in point: Monday saw more than 170,000 contracts change hands.
One bearish S&P 500 spread viewed favorably for positioning is the SPY May $212/$214 bear call spread. Priced for 85 cents, the breakeven is just a dime below the described Cash Dash high of $212.95 that we anticipate isn’t going to be broken.
Should the S&P 500 not abide with our technical assessment, the position maintains limited risk of $1.15 above $214. Below $212 the trader takes in the full credit at expiration. Currently with SPY at $210.77 this gives the trader modest wiggle room of about .50% before the spread has any intrinsic value.
SPY Bear Put Spread
A second variation of the S&P 500 bear vertical that we’re agreeable with is the June $208/$203 bear put spread for $1.28. In this vertical the spread, the trader pays the premium, breaks even at $206.72 and realizes their maximum profit of $3.72 should the SPY fall below $203 at expiration.
Which is the better spread in the S&P 500? An options probability calculator points to the nearer-term and closer-to-the-money May vertical as having the higher likelihood of profit with roughly a 60% chance of the spread finishing fully out-of-the-money and profitable.
Meanwhile the SPY June spread is about 64% likely to finish out-of-the-money and the debit paid, expire entirely worthless. That all said, markets like the S&P 500 are a lot more grey than that. In fact, this spread covers a good bit of the period known as June Gloom.
What’s more, the June SPY vertical still has a 60% or greater chance of testing the breakeven level of $206.72 prior to expiration. With that in mind, it’s easier to warm up to the idea of profitable adjustments as they’re presented, rather than simply buy and hope for the worst in the S&P 500.
As of this writing, investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon his observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT
