With the SPX up 9.25% ytd off to its best start in 15 yrs, I think it could make sense to look for cheap ways to protect against a potential pull back in the market. I know, I know, this is not the first time you have heard this from me, but it is the first time all year that I have suggested portfolio hedging with SPY. A few weeks back I did suggest a hedge with the VIX a bit higher than current levels (read here) and that was a cheap way to get some near term exposure to a potential spike in vol. At one point when the VIX moved above 22 a couple weeks back, this fly was worth double what I paid and offered (still does with 3 weeks left) a fairly decent risk reward.
Chart below shows the obvious inverse behavior of the SPX and the VIX, at some point this relationship will have to mean revert. Obviously this could go on for a while, but as we keep an eye on weakening breadth and momentum indicators, our belief that this is likely to happen sooner than later.
For regular readers of the site, you know that I have been skeptical of this rally, I don’t believe that just the turning of the calendar can make us forget about the ills of the European credit crisis and what will most certainly be a slowdown in economic activity as the region embraces austerity. Today we got our own economic data that appeared to be a mixed bag, while ISM manufacturing was weaker than expected, ISM prices paid were higher, hmmmm. If we get a soft patch of economic data coupled with any earnings pre-announcements as we head into quarter end in the coming weeks I think we see 1300 in the SPX.
If you are long and strong and don’t feel like trimming you could consider some relatively cheap Put Flys in the SPY that offer a good risk reward….for instance……
TRADE: SPY ($137.78) BUY March30th Quarterly 135/130/125 Put Fly for .57
***I executed this for .57 as a n outright bearish bet
-Buy 1 March30thQrtly 135 Put for 1.46
-Sell 2 March30thQrtly 130 Puts for a total of 1.18( .59 each)
-Buy 1 March30thQrtly 125 Put for .29
Break-Even on March30th Quarterly Expiration;
Profits btwn 134.43 and 130 make up to 4.43 (or about 7.3x your money), payout trails off btwn 130 and 125.43, MAX gain of 4.43 at 130.
Losses of up to .57 btwn 134.43 and 135 and btwn 125.57 and 125. Max loss of .57 below 125 (down 9%) and above 135