More Downside Potential for S&P 500 and SPY

This is the time to prepare for another drop

The S&P 500 managed to hold at around the 2,500 level at the close on Friday, and that gives traders a chance for a downside insurance trade on the SPDR S&P 500 ETF Trust (NYSEARCA:SPY).

The Bureau of Labor Statistics’ monthly jobs report was released last Friday, and though it only covered the period ending on March 12, it was bad.

According to the report, the economy lost 701,000 non-farm jobs, which was much higher than expected. Bloomberg compiled consensus data that shows analysts underestimated the effect the COVID-19 outbreak had on the economy in early March.

They were only expecting a loss of 100,000.

And keep in mind, as of last week, the unemployment claims for the last two weeks reached 9.9 million.

As I said on Friday, the V-shaped recovery is looking less and less likely. SPY tracks the S&P 500, which makes it a perfect way to protect your portfolio with a bearish trade.

A Bad Week Starting Strong

The White House has stated that this could be one of the worst weeks for the COVID-19 outbreak, but investors seem to be optimistic. New York has reported its first decline in deaths, but some health authorities seem to think the number of cases could reach a new high this week.

Based on the jump higher in stock futures, investors seem to be focusing on the death count decline.

Last week oil prices jumped, which was a boon to the market, but it looks like oil futures are coming back down this morning. A meeting between the Organization of Petroleum Exporting Countries (OPEC) and Russia was postponed until Thursday.

This shouldn’t be too surprising because last week both Russia and Saudi Arabia said they were not yet negotiating.

That drop in oil prices could contribute to more volatility in the market.

We are dealing with a lot of uncertainty in the market, and traders need to be prepared.

Protecting Your Portfolio with SPY

SPY’s chart doesn’t provide much clarity about where the market is headed. There was a lot of back and forth last week, and this exchange-traded fund (ETF), as well as the index it tracks, could move to retest its lows.

Daily Chart of SPDR S&P 500 ETF Trust (SPY) — Chart Source: TradingView

At times like this, I usually recommend cheap insurance plays. Traders can take a big profit on a downside move without putting themselves at risk of losing too much capital if the market moves higher.

SPY dropped below $220 during intraday trading last week, but I’d like to use a slightly higher strike price. That way, traders can collect a profit if SPY drops without retesting its lows. The stock seems to have support in the $243-$245 range, and I think it could break that support if there is more bad news.

Using a spread order, buy to open 1 SPY April 13th $245 put and sell to open 2 SPY April 13th $234 puts for a net debit of about $0.40.

Note: Be sure you are opening the weekly SPY options that expire on Monday, April 13, 2020.

This is a high-risk trade, so take a small position.

About Ratio Put Debit Spreads

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) help 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 to execute a ratio 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 $234 strike price for every 1 contract that you are short of the SPY April 13th $234 puts. So, this is inherently a higher risk play.

InvestorPlace advisor Ken Trester also brings you Power Options Weekly, which delivers 5 new options trades and his latest trading advice to you each Friday. 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.


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