Shares in the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) closed up 1.54% at $202.35 on Thursday, marking its highest finishing level since Aug. 20.
Citigroup (C) did report better-than-expected results on the earnings side, spurring a sharp rally in the financials. Much of the move higher, however, was attributed to the belief that the Federal Reserve will be on hold until 2016 at the earliest, as gauged by the Fed funds futures signaling that the first rate hike will likely now be in March 2016.
How much higher cheap money can take the S&P 500 is the real question for investors to ponder. With the SPY now trading at a current price-to-earnings ratio of 21.3, stocks certainly are not cheap. Revenues paint an even gloomier picture, with an expected drop of 3.3% in Q3.
Earnings season is off to an inauspicious start, with large-cap companies such as JPMorgan Chase & Co. (NYSE:JPM), Yum! Brands, Inc. (NYSE:YUM), Goldman Sachs Group Inc (NYSE:GS), and Wal-Mart Stores, Inc. (NYSE:WMT) coming in well shy of lowered expectations. Economic data has been tepid at best, with worldwide growth most assuredly slowing.
While SPY has shrugged off these concerns so far, at some point valuations do matter.
Technically, SPY is approaching some major overhead resistance at the $204 level, along with further resistance at the 200-day moving average of $206.05.
Oil prices have weakened recently, and with energy companies such as Exxon (XOM) and Chevron (CVX) comprising over 7% of the SPY, continued weakness will likely start to weigh on the SPY. Plus, the biggest IPO of the year, First Data (FDC), closed lower than in IPO price on the first day of trading — not a sign of robust demand for stocks.
With the SPY seemingly ready for a period of consolidation after the big rally, I favor selling out-of-the-money call spreads on the SPY ETF to structure a defined risk trade about one standard deviation out of the money. With volatility still hovering around the 16 level, options premiums are still rich enough to make selling strategies viable.
SPY Trade Idea
Sell the Nov $209 calls and buy the Nov $212 calls for 50 cents net credit
The short strike is 3.21% higher than the current level of the SPY. The max gain is the 50-cent credit initially received, while the risk is $2.50 for each spread sold. The return on risk is 20%.
I would cover some of the position on a meaningful move past the 200-day moving average at the $206.05 area.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities.
