2nd Update Aug 4, 2011: With the market making new lows I thought it was important to update this structure and talk about trade management. This trade structure and its usefulness can be very instructive as you look to protect your portfolio in the future…..See comments from original post below about why I liked this specific structure, but it I guess the most important thing here is that this cost nothing and mitigated a good bit of risk……let’s break it down:
ORIGINAL TRADE STRUCTURE:
NEAR THE MONEY PROTECTION: SPY 133.60 (5/22/11)-STRUCTURE COSTS NOTHING
-Sell the Aug 137 Call at 2.15
-Buy the Aug 132 Put for 4.05
-Sell the Aug 124 Put at 1.90
Now (with SPY at 123) the structure is worth about 5.90 or almost 3/4 of the width of the spread.
-Sold Aug 137 Call at 2.15 now worthless at .03 (net gain 2.12)
-Bought Aug 132 Put for 4.05 now worth 9.15 (net gain 5.10)
-Sold Aug 124 Put at 1.90 now worth 3.20 (net loss 1.30)
SO NOW WHAT? I would most definitely cover the Aug 137 Call, and at this point you have to make a decision whether it is worth staying long the put spread to make the balance of the spread….and that decision comes down to your level of bearishness….if you think we go lower from here than why not, but if you think at 1227 in the
SPX that we could bounce and possibly rally into next weeks FOMC meeting as rumors of QE3 will be everywhere, than risking a good portion of your spread to make 2.10 doesn’t seem like a great risk reward. That said it is also important to consider how your longs are doing relative to the market…..if they have performed well relative to the market than it may make sense
1st Update June 5th, 2011:
I wanted to take a moment to highlight this portfolio hedging strategy (below) that I discussed on the site 2 weeks ago…..not to do any sort of victory lap (market only down ~2.7% since then, not exactly a meltdown) because this was not intended to be an outright bearish bet on the market, but to help mitigate losses in a long portfolio of stocks in the event of a sell off. For educational purposes lets go through some trade management points… ..
ORIGINAL TRADE STRUCTURE:
NEAR THE MONEY PROTECTION: SPY 133.60 (5/22/11)-STRUCTURE COSTS NOTHING
-Sell the Aug 137 Call at 2.15
-Buy the Aug 132 Put for 4.05
-Sell the Aug 124 Put at 1.90
Now (as of Friday’s close 6/3/11) the structure is worth about 2.00,
-Sold Aug 137 Call at 2.15 now worth .95 (net gain 1.20)
-Bought Aug 132 Put for 4.05 now worth 5.25 (net gain 1.20)
-Sold Aug 124 Put at 1.90 now worth 2.30 (net loss .40)
SO NOW WHAT? The SPY is down 3.00 and the structure that you paid nothing for is now worth 2.00 …not bad I assume, unless you are trying to protect a long position in NFLX (which made new all time highs last week) that your longs went down with the market…..this positioning should serve you just fine….I guess the only thing I would consider doing is covering that Aug 137 Call that you are short…..Maybe wait for one more decent down day and then try to buy it for .50 or so….once that is accomplished you have effectively taken any risk to the upside off of the table and if the market snapped back, your put spread may become worthless, but presumably your long positions should appreciate AND you were able to sleep at night as the market sold off from multi-year highs as you had some form of protection to down~7% in the broad index.
-Also if the market continues to head lower and the Put Spread is becoming more valuable and you think the market is getting oversold at some point just sell the put spread (and if not done already, cover the call) and this will greatly raise your long exposure and position you for the potential snapback…..but don’t get fooled by head fakes, again this wasn’t and outright bet, it was a hedge and meant for protection…..but markets like this make V bottoms when severely oversold and maybe at some point in the next month or so it seems like the sentiment can’t get any worse and market ready for a bounce, then take the sucker off….
———————————————————————————————————-
ORIGINAL POST MAY 22, 2011: SPX GOING BACK TO 1250, THIS SUMMER, CONSIDER SPY PUT SPREAD COLLARS AGAINST LONG PORTFOLIO
Readers of this space know that I have a hefty dose of skepticism as it relates to this market, and have become increasingly convinced that the market is going to correct 10% over the next few months. Being bearish most of the time can leave me feeling a bit lonely, and even though I know I am a Patriot all this negativity about our economy’s prospects leaves me feeling like a Pinhead sometimes…….Well enough fear and loathing, I am convinced the markets are massively underpricing a whole host of risks, especially with the market within a few % of multi-year highs made a few weeks back…..Look to protect stocks that you own, don’t over pay for that protection and if you can, try not to just sell etfs against your portfolio….
Lots of traders that I know have become less long/short, and primarily just long single names and short etf’s. The etfs help to lessen the blow in challenging markets, but most traders do not take into account correlations and properly adjust for betas of their longs. For a lot of reasons (and through experience) I think this is a generally useless endeavor in an attempt to add “alpha” and will attempt to explain an alternative below that costs very little, but does take some concentration and trade management.
***Quick note, this was written last night before markets around the world took a bit of a bath….S&P futures currently down ~1%…..Trade example listed below should be used for educational purposes as the strikes and the actual strategy may not be appropriate for your portfolio and the prices used will most certainly be different this morning. The example is to be used against a portfolio of long stocks not as an outright bearish bet.
But first some quick technical points of reference:
-Since the QE2 trial balloon was floated late August 2010 the
SPX is up ~28% (~1050 to ~1330)
-Since the March 16th Japan earthquake/tsunami lows (~1250) the market is up almost 7%.
-On pure technicals, if the market is going to correct at some point this summer, it will most certainly go through 1300 on is way to testing the previous “panic” intra-day low of 1250 and the closing low of 1257 in March, which sits about 1% above the 200 day moving average at 1238.