An unprecedented daily thrashing in the S&P 500 and oodles of fresh new technical firsts in terms of investor panic have paved the way for short-term opportunities in the S&P 500 ETF (SPY) weekly options for self-directed traders.
The plethora and severity of technical stats being doled out following Monday’s dizzying market action are real eye openers for certain. But of particular notice to this ex-options market maker, the one indicator that’s screaming to buy the falling market knife is the CBOE Volatility Index.
CBOE Volatility Index Daily Chart
The CBOE Volatility Index or “VIX,” regarded as the market’s best fear (and complacency) gauge, went ballistic Monday. Priced off the S&P 500’s options implied volatilities, the VIX registered its largest three-day percentage jump in history as investors seeking protection at (almost) any price, sent prices for puts and other protective contracts through the roof.
Highs of around 53% in the VIX haven’t been witnessed since the financial crisis and during similar investor anxiety in the S&P 500 and other major markets.
We may yet see lower prices in the S&P 500, and in fact I wouldn’t bet against it. But with the mean-reverting VIX rocketing an extreme and nearly 200% above its 10-day simple moving average, there is strong evidence for a playable rally in the SPY before Monday’s lows — which tested the October corrective lows — are tested.
Additionally, the VIX has taken out former historic highs near 45% from 1998 and 2002 and the more common level of 30%. More aggressive short-term traders now have more evidence to support long positions in the S&P 500 for a short-term trade to capitalize on other investors panic and ill-timed exits Monday.
SPY Weeklys Bear Put Spread
In checking the S&P 500 options for SPY and In a session where more than 1 million contracts traded, quoted markets look less-than-liquid based on ultra-wide spreads between bid and asking prices.
To get around this issue, we can use mid-market pricing to obtain a fair value quote in SPY options. Once the S&P 500 opens up, and if the index opened unchanged, the expectation would be for a fill as the options quickly tighten back up as traders begin to make better use of penny increments and narrow the quoted markets.
One spread of interest for short-term traders looking to position in the S&P 500 for a near-term bounce is the Weeklys SPY August 28 $183/$180 bull put spread for a credit of 90 cents or better.
Instead of guessing how high the S&P 500 might go, this strategy is priced to profit as long as Monday’s test of the October lows hold at expiration this Friday. In fact, for a credit of 90 cents, at a price of $182.40, which marked Monday’s worst in the SPY, the trader would profit 30 cents and above $183, the whole credit would be realized.
On the downside and if oversold conditions beget further selling, this bull is protected by the put purchased at the $180 strike. A max loss of $2.10, regardless of price action in the S&P 500, is guaranteed because of the long put contract offsets the sold put and creates a limited risk position.
While there are certainly more creative strategies out there, a vertical spread’s flexibility, simplicity, price guarantees and ability to negate risks are hard to beat. And this former market maker thinks it’s particularly relevant in an environment where many S&P 500 bulls bought the dip the old-fashioned way, chewing off much more than they bargained for.
Disclosure: As of this publishing, investment accounts under Christopher Tyler’s management do not own positions in any of the securities or their derivatives mentioned in this article, but may initiate in the future at their discretion. The information offered is based upon Christopher Tyler’s 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
