New Trade – $SPY Portfolio Protection

by Dan February 11, 2014 1:28 pm • Commentary

On Friday I laid out a strategy for those looking for portfolio protection, or looking to make an outright bearish bet on the broad market that we would go back and test last Monday’s lows, and possibly longer term support at 1700 in the coming weeks.  There was one KEY CAVEAT, we wanted to wait a little bit to see just how far the market had to run, and wait for the price of options to come down further (see post below).  Since Friday’s close the SPX is up about 1.3% and through the index’s 50 day moving avg, a level that I would suspect that causes sellers to emerge.

It is my sense that this is as good of spot as any to lay out a short or add protection to a long stock portfolio as the SPX has re-traced about 80% of the decline since Jan 22nd.  Now with the price of options less than Friday, and the index a bit higher I am going to move up the strikes from the ones I laid out for the hypothetical trade from Friday and get a closer break-even.

Trade: SPY ($181.89) Bought March 31st quarterly 180 / 170 Put Spread for 2.00

-Bought to open March 31st 180 Put for 2.80

-Sold to open March 31st 170 Put at .80

Break-Even on March 31st Quarterly Expiration:

Profits:  btwn 178 and 170 make up to 8, max gain of 8 below 170

Losses: btwn 178 and 180 lose up to 2.00, max loss of 2 above 180


As I initially detailed, a little it higher in the markets would make for a great entry to protect a portfolio. This structure looks out to the end of the quarter and sets up protection between the two big technical levels of the SPX, 1800 and 1700.  I am using the structure though as an outright bearish bet as I like the risk/reward of the near the money $10 wide spread where the short strike is at massive longer term support.



Original Post from Friday Feb 7th, 2014:  Name That Trade – I $SPY With My Little Put Buy 

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.

SPX 6 day chart from Bloomberg
SPX 6 day chart from Bloomberg

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.

VIX 1yr chart from Bloomberg
VIX 1yr chart from Bloomberg

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:

SPX 6 month from Bloomberg
SPX 6 month from Bloomberg

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.

Screen Shot 2014-02-07 at 12.48.05 PM
from LiveVol Pro

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.

SPY 1 year chart from Bloomberg
SPY 1 year chart from Bloomberg