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The major indices opened yesterday’s session in the red before quickly making their way into positive territory within the first few hours of trading. However, they made an abrupt turn to the downside around 12 p.m. ET as President Trump seemed to threaten a retaliation against North Korea for continuing to ramp up its nuclear program.
Despite the dire circumstances, the market did not appear to care all that much, as it only lost a fraction of a percentage point by the close. That being said, my outlook is considerably more cautious going forward.
Historically speaking, August and September are the two worst months of the year in terms of market performance. According to my research, over the last 20 years, the market rose in August in only five of those years, or a measly 25% of the time. Therefore, the odds are stacked against the bulls this month.
Plus, we’re overdue for a correction, and I’d expect one by the fall, when traders are back from their summer vacations and tend to put the market back on a more realistic path. So with this “downside insurance” position I made sure to go with an expiration that reflects that:
Using a spread order, buy to open 1 SPDR S&P 500 ETF Trust (NYSEARCA:SPY) Oct. 20th $240 put and sell to open 2 SPY Oct. 20th $225 puts for a net debit of about $0.63.
A ratio debit spread is simply a way to lower the cost of buying options, as the two options that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this ratio put debit spread is a way to lower the cost of establishing a bearish put option trade. Many brokers will require the use of margin and/or a set amount of reserved capital and/or a margin account to execute a debit spread; contact your broker directly for specific requirements.
Because you are short a naked put in this ratio put debit spread, the risk is that you could be obligated to buy 100 shares of SPY at the $225 strike price for every 1 contract that you are short of the SPY Oct. 20th $225 puts. So, to avoid that, you’ll want to cash out if SPY gets down to $225.
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Ken Trester is editor of the popular Maximum Options program. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.