Apparently the stock market got what it wanted with an agreement on a 'fiscal cliff' compromise that for the most just 'kicked the can down the road'. This is probably just a prelude to the real partisan dogfight in a few months over spending cuts, raising the debt ceiling, and the federal budget. Investors celebrated today not because they like the budget deal that was cobbled together, but because they were grateful we didn't fall off the 'cliff'. Pent up demand ignited all categories of stocks higher. 'Risk-on' trading was in play as the major small cap indexes reached highs from last fall. But actually, over the past five years, the first trading day of the year has always generated big gains. The major stock indexes are getting close to being overbought and prices are already declining in after-hours trading. Now might be a good opportunity to set up a SPY call spread.
SPY ETF Trade Setup
We are opening a January expiration month SPY bear call spread
We want the SPY call spread to generate a minimum .50 net credit AND we prefer an 80% probability that the short call 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 bear call spread (based on Wednesday'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.
If prices gap down tomorrow the call spread may not be available as published and we will hold off on this trade. Conversely if prices rise sharply then we will probably initiate the call spread at a higher strike price with a similar risk profile.
Premium Credit $.56
Total Option Premium Received $1,120 (Excludes commissions and fees)
Maximum Risk $7,840 (includes premium received for the January SPY bull put spread)
Margin Requirement $10,000 (this is the same margin used for the bull put spread)
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)
As with initiating the trade, the decision process for exiting our SPY bear call spread position 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 our short call) 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.