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I expect the market to recover from its recent selloff, but it may struggle in the near term.
During the first few trading days of a new month, the market tends to enjoy a small boost as institutional investors deploy new capital.
However, now that that bullish period is behind us, we are seeing a pull back.
Technically speaking, SPY ran into resistance (horizontal red line) just above the $281 level last Wednesday and Thursday, and it failed to break above that level.
Daily Chart of SPDR S&P 500 ETF (SPY) — Chart Source: TradingView
Shares turned around and moved lower on Friday, but most of the damage was done during yesterday’s session, as SPY fell more than 5 points, or 1.9%, to close at $272.48.
While there is some short-term support between $270 and $271, if SPY starts to fall further, it would not be a bad idea to own some portfolio protection.
Therefore, I want to make a downside insurance play using put options on the SPDR S&P 500 ETF (NYSEARCA:SPY), the ETF that tracks the performance of the S&P 500.
Using a spread order, buy to open 1 SPY Dec. 7th $270 put and sell to open 2 SPY Dec. 7th $261 puts for a net debit of about $0.10.
A ratio debit spread is simply a way to lower the cost of buying options, as the two option(s) 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 $261 strike price for every 1 contract that you are short of the SPY Dec. 7th $261 puts. So, this is inherently a higher risk play.
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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.
