The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) breached numerous support levels during last week’s drubbing. And that spells trouble for many reasons. Chief among them is the notion that old support becomes new resistance. With all these potential ceilings now looming overhead, rallies in SPY are suspect.
For all its fury, the Friday-Monday rebound hasn’t changed the technical picture of the SPY much. It remains locked in a downtrend with lower pivot lows and lower pivot highs. The 20-day moving average has rolled over, and the 50-day isn’t far behind. It appears we’re seeing a regime change where the buy-the-dip crowd becomes a sell-the-rip one.
With the CBOE Volatility Index (VIX) now whipping around between 25 and 40, I suspect high volatility will be with us for a spell until calmer heads finally prevail. In such an environment, it usually pays to fade extremes. That is, use large rallies as an opportunity to deploy bear trades and big sell-offs as a chance to initiate bullish ones. Think of SPY as a rubber band and wait for it to get stretched in one direction or the other before placing your bets.
At yesterday’s peak, the SPY had risen 5.6% from Friday’s lows. That’s a substantial gain in such a short period. That leads me to believe we could see some backing-and-filling here or perhaps another plunge into the deep. Either way, the following trade idea is positioned to thrive.
SPY Bear Calls
While buying puts may not be a bad way to go, the high implied volatility is creating some alluring credit spread trades. If you think the SPY continues to flounder and remains below $273 for a few weeks, then sell the March $273/$278 bear call spread for around 92 cents.
The max profit is limited to the initial 92-cent premium and will be pocketed if the calls expire out-of-the-money. The max loss (and cost) is $4.08. By risking $4.08 to potentially capture 92 cents, this vertical spread offers a potential 23% return on investment.
If the SPY is somehow able to climb out of the abyss here, consider exiting on a pop above $273 to minimize the damage. Also, if we get a rapid price drop this week and you capture 50% of the max reward (i.e., 46 cents) quickly, then consider bailing.
As of this writing, Tyler Craig didn’t hold positions in any of the aforementioned securities. Want more education on how to trade? Check out his trading blog, Tales of a Technician.