As markets celebrate seven years of bullishness, the debate rages around the next phase. The SPDR S&P 500 ETF Trust (SPY) is about 6.6% off its all-time highs.
But they haven’t been all winners. Apple Inc. (AAPL) is still more than 20% off its highs.
While there could be more upside room, I personally believe that markets are top heavy. We will need new fundamentally based positive catalysts to chase new highs and we don’t currently have them.
So for this to happen, we need a sharp upturn in global economic outlooks, which currently seem to be fading. Otherwise, we would need a new round of Federal Reserve quantitative easing, or QE. This is highly unlikely since the Fed just started a tightening cycle.
So until then, the easier path for the SPY is down.
Click to Enlarge 2016 has so far been a trade of headlines, mostly centered around oil prices, so it won’t take too many negative headlines to send markets lower. The last test of the lows came too easily. Furthermore, the bounce only came off a suspiciously well-timed oil rumor.
Technically, the SPY is vulnerable to a severe drop if the recent lows were to be tested again and don’t hold. However, I don’t believe that we are on the verge of an imminent collapse. Fundamentals are not that bad.
So, I want to capitalize on a measured down move with as little cost as possible.
Trades for SPY, AAPL Stock
I can accomplish this in two trades plus a third optional addition. The main trade is to short the markets using puts in the SPY. The second trade is bullish Apple stock. Its role is to hedge and bring in funds to finance the short. The third, optional trade will add to the SPY short and bring in even more funds to finance the main trade.
Click to Enlarge Why risk being long Apple stock while my thesis is that markets will fall? I believe that AAPL will hold up better than the general markets in selloffs. Apple has a relatively high intrinsic value thanks to its cash hoard. Furthermore, the Apple stock price is well-defended by sizable buyback and dividend programs.
I feel that the $75 per share level is relatively safe between now and the January 2017 option expiration.
- Trade No. 1 — The Short: I buy a May SPY $190 put. This is a bearish trade for which I pay $3.30 per contract to open. I chose May to give time for markets to realize that Fed Chairwoman Janet Yellen will be raising rates again this year. I could chose any expiration to change the cost, but I like May.
- Trade No. 2 — The Bank: I sell a January 2017 AAPL $75/$70 credit put spread. This is a bullish trade for which I collect 65 cents per contract. This has a high chance of success and a 15% potential yield on dollars at risk. This leaves a 25% buffer from current prices. I don’t mind owning AAPL at $75 per share in the next few months, so max risk is not a deterrent to me.
- Optional Addition to Trade No. 1 — Another Source of Funds: I sell July SPY $215/$217 credit call spread. This is a bearish trade for which I collect 38 cents per contract to open. This is a 21% potential yield on money at risk. I have a 70% theoretical chance of success and an 8.5% price buffer from current SPY price.
I can close any of these trades at any point in time if the story-line changes.
Selling options can be risky if managed incorrectly, but I particularly enjoy the control they provide. I like knowing the best- and worst-case scenario from start to finish of every trade.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
