The stock market had been on fire since February 2016. Even after this dip the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) is still more than 20% higher than the February low. Equity markets as a whole have been behaving like momentum stocks (a.k.a. MOMOs).
When MOMOs are rallying, they are so hot that they seem perpetually over-valued, thereby keeping most investors out. Conversely, when they are falling, they seem like falling machetes too scary to catch.
So how do I invest in something this erratic? The bullish thesis was for the most part built upon hopes for fiscal spending promised to us by President Donald Trump. Investors quickly priced in the perfect scenario. From here it’s a matter of chipping away at that perfect statue.
Click to Enlarge I take a balanced approach. I don’t short the bullish thesis with full force and I have to be cautious on both ends. Here is an example of a SPY ETF write that delivered over 20% on money risked.
Yes, the S&P 500 is near all-time highs but individual companies like Apple Inc. (NASDAQ:AAPL) or Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) are not outrageously expensive. Nevertheless, I have to account for some downside buffer in the bullish part of my trades. After all we do have a few mega caps that have set astonishing new at all-time highs. Amazon.com, Inc. (NASDAQ:AMZN) and Tesla Inc (NASDAQ:TSLA) are two that come to mind.
How to Trade the SPY
The Bullish Side: Sell the SPY Sep $210/$205 credit put spread for 60 cents per contract. This trade has a 90% theoretical chance of success. I need SPY to close above my spread in mid-September to win.
Usually I like to balance my trades by selling opposing risk. But I have to still respect the so-called ‘animal spirit’ in the current equity markets.
The Bearish Side: Sell the SPY Sep $250/$255 credit call spread for 75 cents per contract. This spread has a 75% theoretical chance of success. This is tighter than my usual comfort starting zone but makes sense near all-time highs.
Taking both trades, I would have sold an iron condor with +6% and -10% moves from here. This pair trade would yield over 30% it both spreads expire worthless for maximum gains. I could book partial gains or losses in either spread at any time if I want.
Learn options as easy as 1-2-3 here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
