SPY: Make a Fed Week Bet on the S&P 500

Active investors should consider a lottery ticket trade in the SPY ahead of this week's FOMC meeting

Last week, the S&P 500 — as represented by the popular SPDR S&P 500 ETF Trust (NYSEARCA:SPY) — tumbled about 3.6% as the free-falling price of oil and uncertainties around this week’s Federal Open Market Committee meeting weighed on risk assets from stocks to junk bonds.

SPY: Make a Fed Week Bet on the S&P 500Two factors this week however argue for a bullish posturing on the part of active investors:

  1. Stocks tend to bottom around mid-December before starting a traditional year-end rally.
  2. Stocks tend to lift into Friday’s quadruple witching options extirpation.

Given these two factors, plus the fact that the SPY just reached the lower end of its multi-week range, I think that a calculated bet on the long side is worth it in my opinion.

Much is in the hands of the Fed this week. Many economic data points continue to come in worse on sequential and year-over-year bases, junk bonds are signaling something much worse and the price of oil and other commodities are still in free fall. Typically this is not the type of environment that lends itself well to an interest rate hike.

Hawks, on the other hand, argue that the Fed just wants to push away from the zero percent interest rate boundary and give itself more wiggle room.

Fund managers seem to be freaking out ahead of this Wednesday’s FOMC interest rate decision, and the price action in oil is not helping brighten their moods. If we take a step back, however, and consider the typical seasonal pattern for the month of December for the S&P 500, we see that thus far we are still in line with this seasonal pattern.

SPY ETF Charts

On the first chart is the December price action in 2014. Note the 5% pullback into the middle part of December, from which a year-end rally was born.

To respect both sides, we are in a different spot in the economic cycle this year, and this seasonal pattern does not work out 100% of the time. But not respecting the strong tendency for year-end tailwinds in stocks is just bad betting.

S&P 500 SPY 2014
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On the next chart is the S&P 500 this year. We can see that from the early November highs, it is so far still tracing out a classic ABC correction, which tends to lend itself well to at least a bounce/rally back toward the top of Wave B (so, back to the year-to-date highs).

S&P 500 SPY 2015
Click to Enlarge

Lastly, on the daily chart of the SPY ETF, we see that it has arrived at a confluence area of support made up of horizontal and diagonal lines. While options premiums (i.e. implied volatility in options on the SPY ETF) increased last week, they are still somewhat cheap with cheaper implied volatility in calls than in puts, which usually is the case.

SPY ETF daily chart
Click to Enlarge

As such, active investors wanting to take a moderately bullish bet this week and into year-end could consider buying some at-the-money or slightly out-of-the-money January call options on the SPY ETF. If history is any guidance, then both seasonality and this week’s quadruple witching options expiration still stand a decent chance of giving stocks a boost in the last two weeks of 2015.

A break and hold below the $199 area in the SPY would alter this picture, while on the upside an initial price target of $210 looks attractive.

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