A very easy way to play a falling market is to buy two month forward puts in the SPDR S&P 500 ETF (NYSEARCA:SPY). Given all the forecasted bad economic news likely to hit between now and June 17, when these puts exercise period ends, the price may not be too expensive. This article will explain how simple it is to accomplish buy SPY puts if you believe SPY stock will fall.
You can see the prices for the Jun 17 SPY puts by going to the Yahoo Finance option chain for SPY dated June 17. This page shows the prices of the SPY calls first. You have to scroll down until you get to the “Puts” section.
One of the best put prices is the $400 exercise price. This, it turns out, is $26.04 below the price today of $426.04 for SPY. So by buying these puts, almost two months in advance, you expect that the market will fall below $400 by then. That is a decline of 6.1% over two months (i.e., $26.04/$426.04).
SPY Stock Will Fall — But by How Much?
That is the profit motive you have for buying these puts. You expect that the price of the stock market, as seen by the SPY puts, will decline more than 6.1% below today on or before June 17. That does not seem too unreasonable. After all, even Schwab’s economist is predicting that inflation will cast a deep shadow over the U.S. economy. He argues that a smaller spread between the S&P 500’s forward earnings yield and the 10-year U.S. Treasury yield indicates that stocks look less attractive relative to bonds.
How much below $400 does SPY have to fall before you make a profit buying these puts? Well, let’s see. The asking price is $8.73, as of the close on Friday, April 22. It will have a different price when options markets open on Monday, April 25. But just for reference, that means that just to break even the SPY price has to fall from $400 less $8.73. That means its breakeven price is $391.27, which is 8.16% below today’s closing price of $426.04. So if you buy these puts you must believe the market will fall more than 8.16% by June 17 or earlier in order to make a profit.
That does not seem too far out of the question, especially given how volatile the market has been. So far this year SPY stock is down 10.3% from $474.96 where it closed last year. Expecting to fall another 8.1% is not that unrealistic.
One last point. How much does one Jun 17 $400 put actually cost? Since each contract is worth 100 ETF shares, and since the price is $8.73, the total cost, before commissions, is $873.00 (i.e., 100 x $8.73). Your actual price will be different at the time of purchase. So if you wanted to spend 1% of your $200K portfolio to buy insurance like this, you would buy two to three contracts, or $1,746 for two contracts, and $2,619 for three contracts. Keep in mind this is illustrative only and not financial or tax advice for anyone.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.