Don’t Drink the Rally Kool-Aid: It’s Time to Get a Bit Short!

Where is most of your money stashed? I’m not trying to get personal, I promise! But, I’m willing to bet the bulk of it is in your retirement account.

Another question: Will the stuff in your retirement account be happier if the market goes up or down? The answer is probably, “Up!”

Your portfolio likely has a strong bullish bias. 2008 hurt so much because most of your assets were in the market when everything fell apart between the eight months of torture between September 2008 and March 2009.

Do I know something you don’t know about the market? Of course not. What I do know, however, is that your portfolio is probably leaning long and the market is trading in the upper end of the range. And with those kinds of conditions, I’d personally like to start having a few put options around.

In particular, I’m going to focus on the SPDR S&P 500 (NYSE:SPY), which is currently trading at $131.54. The one-, two- and three-year high is around $135.

You still have to respect the trend, which is up, but I’m starting to get some bearish soldiers ready to help out all my bullish soldiers who are getting a bit excited about the upside.

SETUP: Because the trend is up, this is looking like the right time to scale into some puts.

STRATEGY: With SPY trading at $131.54, I might start to nibble and buy the SPY March 127 Puts at $2.

“Nibbling” means buying maybe 30% of my intended position size. That is, if my preferred trade size is nine contracts, I might buy three to start, then buy three more — maybe at $133 in the SPY — and work up to nine contracts from there.

Why does buying puts with a March expiration make sense here? That’s because I want to give myself time with this trade (March expiration is more than 50 days away), and the option premiums are cheaper than they usually are.

Get Short, Without Short-Changing Yourself

Now let’s talk about the entry price for a moment. You say, “Dan, the March 127 Puts are trading at $2.28; how are you going to get $2?” Well, there is a phrase that says, “Let it come to Papa.” This means that if the market is in a bit of a trend, you don’t need to be aggressive with the price.

When would this order get executed?  Probably when SPY hits between $132.50 and $133. I might use a Good Till Canceled (GTC) order when entering this trade.  Because I am entering my price below the market, it make take a few days to execute, so a GTC order means my $2 bid will stay active and I don’t have to put in a fresh order every day.

What if the market goes down before I make my put purchase? We miss it! That’s part of the game. This is more of a passive put purchase plan; if I wanted to be more aggressive, I’d pay more. However, right here and now I think it’s important to respect this trend, so it should pay to be a little passive.

Indicator to Watch

The Chicago Board Options Exchange’s Volatility Index (CBOE:VIX) weights the implied volatilities of several S&P index options to convey the market’s expectation of volatility over the coming 30 days. If it hits the 24 to 25 area, start evaluating your retirement account to see if you need some downside help.

I don’t want you to stop enjoying the upside bliss, but I do want you to be aware of when the wind might be changing to the downside. (Remember “Mary Poppins”!) The 24-25 area would be an indicator the market is starting to move down, but it’s not out of control yet. Merely a warning worth looking at!

If the trade goes against me, I will discuss a few adjustments I usually use to fix a put gone bad.  Stay tuned to this space for more updates about the VIX, this SPY trade and more trading ideas to come.

Have a great day, and I look forward to touching base with you again soon!

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