Equity indexes recovered from triple-digit lows after the market got a whiff of a potential budget deal. Stocks dropped after Senate Majority Harry Reid warned that a deal was unlikely before the deadline. But traders found a reason to push prices back up and trigger short covering after the House of Representatives announced they would reconvene on Sunday ahead of the fiscal cliff deadline. Also, the White House announced that Senate Democratic leader Harry Reid, House Speaker John Boehner, Senate Republican leader Mitch McConnell and House Democratic leader Nancy Pelosi are attending a Friday meeting to continue budget negotiations. Now is probably a good time to take advantage of the opportunity to set up a January SPY put spread.
SPY ETF Trade Setup ---------------------------------------------------------
We are opening a January expiration month SPY bull put spread
We want the SPY put spread to generate a minimum .50 net credit AND we prefer an 80% probability that the short put contracts will expire worthless and we get to keep most of the sold premium. The spread in the table below complies with our trading rules for initiating the January expiration month option series SPY bull put spread (based on Thursday's closing prices). The suggestion is to submit an order to purchase/sell the option strikes prices below. Please confirm the correct option symbols with your broker.
Premium Credit $.52
Total Option Premium Received $1,040 (Excludes commissions and fees)
Maximum Risk $8,960
Margin Requirement $10,000
20 contracts traded on each leg (number of contracts can be increased or decreased based on risk tolerance and/or funds available to trade; this will impact Total Premium Received, Maximum Risk amount, and Margin Required)
If prices gap up tomorrow the put spread may not be available as published and unless the gap is filled we will hold off on the trade. Conversely if prices drop sharply then we will probably initiate the put spread at a lower strike prices with a similar risk profile as described above.
As with initiating the trade, the decision process for exiting our SPY credit spread will be simple:
Anytime the market maker is willing to accept a limit price of less than .10 on one of our short strikes, we can buy back all the short contracts and sell the long positions on the same spread. However, if it is a week or so prior to the expiration date, we may be able to hold out for a .05 bid or lower.
If one of our short strikes is penetrated (closing price above below the short put) AND the delta rises to .65 we will look to close out this spread (buy the short contracts, sell the long) and roll it out to another short strike price. Unless this is option expiration week, do not panic and rush to close the trade, many times the market will reverse itself and remove the sense of urgency. If one of our short strikes has been violated and there is no price reversal, we cut our losses and live to fight another day.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.