Give This Cheap SPDR S&P 500 ETF Trust (SPY) Trade a Chance

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As we reflect on the passing of the late, great John Lennon exactly 36 years ago today, one of my favorite Lennon songs is “Give Peace A Chance.” With the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) ripping to new all-time highs yesterday and the CBOE Volatility Index just off the yearly (and all time) lows, I think the combination of expensive stocks and cheap options sets up for a high-probability trade in the SPY.

All I’m saying is to give puts a chance.

Since the victory by President-elect Donald Trump, stocks have been on an epic run higher, adding more than 5% in just the past month. The SPY, as a result, has now reached an extremely overbought reading of 73 on a 14 day RSI basis. The last time the SPY was this overbought occurred in late November 2014, which portended an intermediate-term high and a sharp 3% selloff.

SPDR S&P 500 ETF Trust SPY chart view 1
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From a valuation standpoint, the S&P 500 is most assuredly in nosebleed territory. The SPY is now trading at nearly 2 times sales, by far the highest level since 2002. I like looking at P/S as opposed to price-to-earnings ratios, since P/S figures are a cleaner number. They’re not prone to the financial engineering and buyback effect evident in P/E ratios.

SPY

As an options analyst, I always have an eye on implied volatility (IV) when formulating trade ideas and strategies. The most widely known measure of implied volatility is the VIX, which is derived from the S&P 500 option prices on a 30-day basis.

While many refer to the VIX as the “Fear Gauge,” implied volatility is really just another way to look at the price of options. When IV is high, options are expensive and when IV is low, options are cheap.

The VIX currently is priced near the lowest levels of the year; or, in other words, option prices are really cheap.

VIX chart view 1
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Interesting to note that the last time VIX was this low was late August, which marked a short-term top in stocks.

So with stocks at way overbought and expensive levels, and with options going for super-cheap, I like a put play here.

How to Trade the SPY Here

Buy to open SPY Jan $224 puts @ 3.75.

These are the traditional monthly options that expire 1/20/17. The trade is long options, so it is also long vega, or volatility, meaning an increase in the VIX will be a definite benefit.

Since options are a wasting asset, I would use a time stop on the trade and exit near year-end if the position hasn’t moved favorably.

As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.

Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, four years as Lead Options Strategist at ThinkorSwim and three years as a Market Maker for First Options in Chicago. Tim makes weekly appearances on Bloomberg TV  “Options Insight”, Business First AM “Trader Talk”, TD Ameritade Network “Morning Trade Live” and CBOE-TV “Vol 411” to discuss everything from volatility and option related.


Article printed from InvestorPlace Media, https://investorplace.com/2016/12/cheap-spdr-sp-500-etf-trust-spy-trade/.

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