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.
To add this position you need to execute two separate trades simultaneously
1) Sell short the S&P 500 SPDR March 2012 (SPY) $139 Calls at $.72 to take in option premium
2) Buy the S&P 500 SPDR March 2012 (SPY) $145 Calls at $.10 to cap your risk
expiration date: 3-17-2012
Portfolio weighting: 100% only when the (SPY) expires between $139-$145.
($100,000/$139/$.62) = 12 Contracts
Note: this is and out of the money naked option short, requires a level four option trading approval
Margin requirement: $7,300
I think the stock market is in the process of putting in an intermediate top. We are getting perilously close to the 1,360 top I predicted in my best case scenario last October. In fact, we are already at the yearend target put out by the majority of market strategists only a month ago. It kind of makes the next 11 months look pretty boring.
The great irony is that the stock market is making this euphoric run just as the fundamentals behind it are beginning to deteriorate. Corporate earnings are showing signs of a dramatic shrinkage in Q4. I love these kinds of contradictions and anomalies as they are what usually make my year. Even if the market continues to rise, its rate of ascent should slow appreciably as we approach multi year highs.
So, I am going to use the Friday spike in the stock market caused by the blowout January nonfarm payroll report to take in some options premium. Specifically, I am selling short the S&P 500 SPDR March 2012 (SPY) $139-145 Call Spread at a net $0.62.
This trade may be a little more sophisticated than some individuals are familiar with, and it does require a level four (higher) options approval from your compliance department. But the purpose of this service is primarily educational, so I am going ahead with the trade alert. If you are not totally comfortable with this trade, just sit back and watch how it plays out in the market on paper. I can tell you that professional hedge fund traders do these all day long.
By selling short the (SPY) $139 calls, I can take in the premium on a strike that is 3.6% higher than where the market is trading today. To get that high, the stock market would have to continue rising at slightly less than the same rate that it has since January 1, something I am happy to bet against. The March options expire in less than six weeks, meaning that accelerated time decay will be working in our favor. And we get a free holiday (president’s day) thrown in to boot.
Balancing this trade with a purchase of the $145 calls limits your risk to $5.38, or $6,456 on you notional $100,000 model portfolio. It has the additional benefit that it cuts your margin requirement by half and lowers your clearance requirement. It also prevents you custodian, risk manager, client, or spouse from having a heart attack, something naked shorting of options with their unlimited risk have been known to cause.
This trade is profitable at all points under $139.62 for the (SPY) at the March 16, 2012 expiration. If we have any kind of dip before then, the value of this call spread will vaporize. It is a good trade to have on if you expect to get a choppy, ragged top over the course of the next few weeks.
More aggressive short positions will have to wait until later when more of the market’s upside momentum bleeds off. These will include purchases of outright puts on the major stock indexes and individual high beta stocks, long positions in the (VXX) ETF, and calls on the (VIX).
The maximum profit for the 12 contracts in trade is $744 when the March option expiration occurs below $139 in the (SPY). That will add 74 basis points to the value of your notional $100,000 model portfolio, not a bad return for a month of non-work.
There is another intelligent, lower risk trade to do here. That is to write calls against your existing individual long equity positions. It is a great way to take in added income when you are unable to sell out long stock positions for tax, regulatory, or strategic reasons.
Sell the March expiration for the best bang per buck and the most favorable risk/reward ratio. Worst case, you end up selling your stock at higher prices, which is not the end of the world for most money managers and probably something you want to do anyway.