Follow Up to Trade Alert – (SPY) April 22, 2013

As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price.

Further Explanation to: Trade Alert – (SPY)

Buy the SPDR S&P 500 (SPY) May, 2013 $143-$148 call spread at $4.63 or best

Opening Trade

4-22-2013

expiration date: 5-17-2013

Portfolio weighting: 20%

Number of Contracts = 43 contracts

Last week’s terrorist attack is behind us, and so is the worst week of the year for the stock market. The unfortunate events in Boston did manage to push the major equity indexes down to the bottom of an upward sloping channel that has prevailed for the past six months.

That gave us the 2.5% pullback, which has proved to be the reliable, although frustrating buy in point for bulls all year. I am going to stick with this until proven wrong, no matter how insane this may sound. So it is back to “RISK ON”. But this time, call it “RISK ON” light.

Please note that this is a much more cautious position than those I was taking last November. Risk levels are much higher the longer in the tooth this move becomes. We are also just seven trading days from the dreaded May in which a ferocious selloff generally ensues. There is a chance here to catch a quick pop and collect some nice time decay until that happens. Enough companies are beating earnings expectations, some 60%, to make that a strong possibility.

It is possible that this is the move that gives us the double top that presages the summer correction. In that case, we should rally $4.5 in the (SPY) from here to the previous all time high of $159.5, where it then fails. That would give us a chance to harvest some nice profits in this position, provided we are nimble enough.

If we hit those numbers, then we are really going to have to consider some new short positions. This year’s summer correction could run to 10%. You want to look at the (SPY) put spreads and the leveraged short ETF (SDS). You also want to contemplate put spreads in the Russell 2000 (IWM).

That is because in down markets small caps fall 150%-200% faster than large caps. This occurs because in a slowing economy small caps suffer more, see faster credit downgrades, have less access to capital, and see more dramatic contractions in their business.

The basic cycle you are trying to exploit here is to be long growth technology stocks early in bull markets, long large cap industrials and defensives in mature bull markets where we are now, and short small caps in bear markets.

Having said all that, this position is father out of the money and with a shorter expiration than other trades that I have executed this year. This makes it less risky. We would have to see a top to bottom correction of more than $11.87 in the (SPY), or 7.4%, before we lose money on this trade. And it has to do this in less than four weeks. That is a bet I am happy to make.

The best execution can be had by placing your bid for the entire spread in the middle market and waiting for the market to come to you. The difference between the bid and the offer on these deep in-the-money spread trades can be enormous. Don’t execute the legs individually or you will end up losing much of your profit.
Keep in mind that these are ballpark prices only. Spread pricing can be very volatile on expiration months farther out.

Here are the specific trades you need to execute this position:

Buy 43 May, 2013 (SPY) $143 calls at……………$12.27
Sell Short 43 May, 2013 (SPY) $148 calls at.…….$7.64
Net Cost:………………………………………..…….$4.63

Profit: $5.00 – $4.63 = $0.37

($0.37 X 100 X 43) = $1,591 – 1.59% for the notional $100,000 model portfolio.

SPY 4-22-13