For all the hemming and hawing about this week’s market volatility, as I write at 3 pm, the SPX is in the exact same spot of where it was at this time last week.
It was a bit of a volatile week to say the least with U.S. equities having their worst one day loss Monday (SPX down -2.2%) in months on the heels of disappointing manufacturing data only to have today’s action totally disregard this mornings second straight monthly payrolls miss with more 1% gains as I write.
As one would expect, as the dust appeared to be settling, the VIX got nailed, down about 30% from Monday’s highs, but still up about 25% from the lows made in early January.
If you are long strong U.S. equities, and found yourself scratching your head this week, first as to why we were down so much on Monday, and then why we are up so much today, but also remembering the feeling of wishing you had some portfolio protection in the throes of Monday’s sell off, then this might just be the time to slap some on!
Next week should be a less busy week on the data front, but investors will be captivated by new Fed Chairwoman Janet Yellen’s first appearance in front of Congress. Any inclination that the Fed has set its course and won’t be pulling back from QE (a pretty safe bet in our opinion) could rile the markets a bit.
The 6 month chart of the SPX tells a fairly interesting story, the 6% decline from the all time highs in mid January retraced to a level that most savvy technicians would have expected the decline to at least pause, coming within 1.5% of the largest peak to trough decline of the past year.
In the near term if I are looking for protection I would be focused on this week’s low of about 1740, and expect it to be breached, and if so it could be a quick trip to longer term support at about 1700, which also corresponds with the 200 day moving average:
If the SPX follows through on its current gains I would expect a re-test of the 50 day moving average (about 1810 above in purple) but would also expect to find some resistance at those levels. If there is follow through we could see one more melt down in implied vol across the board which could make purchasing portfolio protection at that time even more attractive.
The one year chart below of 30 day at the money implied vol for the SPY (red line) shows the fairly dramatic decline in the prices of SPY options this week, but a move to below 12 could be the time to look at put spreads for protection or for a relatively cheap play for another equity flare up.
This is not a trade that I would do right now, but in the event we get one more up day:
Hypothetical Trade: SPY ($179.50) Buy March 31st 175/165 Put Spread for 1.50
-Buy to open March31 175 Put for 2.30
-Sell to open March31 165 Put at .80
Break-Even on March31st Expiration:
Profits: btwn 173.50 and 165 make up to 8.50, max gain of 8.50 below 165, thats about 5% of protection in the event the market is down about 8%
Losses: Btwn 173.50 and 175 lose up to 1.50 and max loss of 1.50 above 175, or 1% of the underlying.
Rationale: This sort of spread can help lower your portfolio’s delta exposure with relative low cost. I chose the strikes as a break of the 200 day moving average at about 1700, would definitely put the October low of about 1650 in play, which corresponds with $165 in the SPY. This would be solid, but cheap protection in the event of an 8-10% decline in the next month and a half.