Try This Options Trade for the Coming Breakdown


Profitable stock trading is all about forecasting where the market is going to go.  Option sellers, however, view the world through a different lens.  For them, profit means forecasting where the market isn’t going to go.  Rather than buying stocks or options they believe are poised to surge in value, most option sellers are on the lookout for options that are likely to expire worthless.

With the SPDR S&P 500 (NYSE:SPY) exchange-traded fund currently testing the $112 support level for about the 10th time in the past two months, suppose we believe a further breakdown is imminent.  While option buyers could purchase a put option hoping it rises in value over the coming days, an option seller may elect instead to sell an out-of-the-money call or call spread that should expire worthless if the SPY does indeed head lower.

For example, traders could sell the October 122-127 call spread by selling to open the 122 call and buying to open the 127 call for a net credit of 50 cents.  In doing so, they are essentially betting the SPY will remain below $122 by October expiration.  If they are correct, they stand to gain a $50 reward. And they certainly have a high probability of profit:  after all, the SPY could fall from here, move sideways, or even rise in value up to $10 before the short 122-127 call spread would result in a loss at expiration.

For those looking for a high probability play to exploit more selling in the SPY, the Oct 122-127 call spread sale looks alluring.

At the time of this writing, Tyler Craig had no positions on SPY.

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