Options Trading: Has SPY Risen Too Far?

Posted On January 17, 2018 2:04 pm
By: Steve Smith

Yesterday, stock indices had a big gap higher and then a sharp reversal lower on huge volume. In the past, this type of key reversal would have a high probability of leading to a few days of continued weakness. And given the magnitude and recent acceleration of the rally, one might go so far as to say yesterday was a mini- ‘blow-off’ top. Today’s options trading will hinge on this assumption.

Indeed, interesting statistic tweeted this morning on just how steep and unprecedented the start of this year is that “when the Dow crossed 26,000 intra-day, the market is rising at >0.4% for 2018’s first 10 days (a rate = to Dow 50,000 by August). During the heady internet bubble’s climactic Q4 of 1999, the market rose at only ½ this pace (0.2% daily). And rarely able to sustain >0.4% for any 10-day stretch.”

Typically, one might expect another day, or three, of profitable taking. But alas, the new normal is to BTFD and create ‘V” lows, and this morning we once again see stocks snap back.

Things may be different, but I don’t think they’re that different. I have to believe investors and money managers are starting to think about taking some profits, especially those that held off for new tax treatment, rather than plowing new money in at these levels.

Therefore, I think the SPY high of $280 hit yesterday will be tough to surmount over the next week. Now it’s time for the options trading.

With the SPY now 11 percent above it’s 50 dma, and reversal at the $280 level, I think this offers a good spot for selling call premium.

I want to generate some income with the sale of a bear call spread.

Specifically:

-Buy to open 6 contracts SPY Jan. (1/26) 280 Calls
-Sell to open 6 contracts SPY Jan. (1/26) 282 Calls

For a Net Credit of $0.60

This position will benefit from time decay, and I will get to keep the premium collected if shares of SPY are below $280 at next week’s expiration.

I will manage risk by using a close above $280 to exit position.

Tagged with: options trading

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.