Last week, I recommended a bearish, downside insurance trade on the SPDR S&P 500 ETF (NYSEARCA:SPY). The S&P 500, and the market in general, has been very volatile for the past week, and some readers may have had trouble getting in for my recommended price as a result.
I was bullish on the market last Friday, and with support at around the 2,840 level holding, I still think a recovery bounce is possible. But the market is always trying to fool you, and that’s why I want to recommend another bearish downside insurance play on SPY.
Dropping After Powell’s Speech
There are a lot of things putting stress on the market right now.
Italy’s new leadership is struggling to form a goverment, which is just another economic stressor for Europe. The EU is already dealing with poor manufacturing numbers from Germany, and we still have the looming quagmire of Brexit hanging over the market.
But last week, I was watching two things: trade and the Federal Reserve. Initially, President Trump was talking about progress in trade negotiations with China, but that quickly gave way. And Powell, in a speech on Friday, made a point of saying that “fitting trade policy uncertainty into this framework is a new challenge” for the Fed.
He also noted that monetary policy “cannot provide a settled rulebook for international trade.”
If traders were expecting another rate cut to alleviate the problems caused by the trade war, it doesn’t seem like they are going to get it. While Powell said today that the Fed “will act as appropriate to sustain the expansion,” markets started to pull back after he stated that the outlook for global growth “has been deteriorating since the middle of last year.”
After the Pullback, Traders Should Prepare for Volatility
Looking at SPY’s chart, you can see just how severe Friday’s drop was. I still think a bullish bounce is possible at this point, but in the event that SPY drops back to support below $280, traders should be ready.
Daily Chart of SPDR S&P 500 ETF (SPY) — Chart Source: TradingView
You don’t want to fill your portfolio with expensive downside insurance trades, which makes a ratio put debit spread a great strategy. It’s no more expensive than a few cups of coffee.
Because of the volatility, you may even be able to earn a credit when taking this position, which would be even better.
Using a spread order, buy to open 1 SPY Sept. 20th $280 put and sell to open 2 SPY Sept. 20th $271 puts for a net debit of about $0.15.
Note: Be sure you are opening the monthly SPY options that expire on Friday, Sept. 20, 2019.
About Ratio Debit Spreads
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 $271 strike price for every 1 contract that you are short of the SPY Sept. 20th $271 puts. So, this is inherently a higher risk play.
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