$SPY Mixed messages. What knock-on effects to take advantage of?
Stock market will continue its bull run...
ECB unveils €1.1tn QE plan to stimulate eurozone economy...
Larry Summers: The ECB's QE won't work...
The bubble will burst...
These are mixed sentiments that you might hear on the news and over the media. Many investors continued to buy into the all-time high in the S&P500 while other traders and investors that held a bearish view in U.S. equities last year were hurt by the continuing bullish S&P growth and threw in the towel trying to short the market. What probably hurt even more was that this growth was "stable" in the midst of escalating geopolitical tensions, poor economic news releases, outright war in certain countries, and questionably experimental central banking policies.
Where will the market go this year? What is the next price level on the S&P500 for it to hit on the upside? If there is a crash, how hard would it crash? What level should I get out at? Should I buy gold? Will Oil go back up?
The way I approach these questions to plan a trade or investment is less direct. Calling a market top or a market bottom or a specific price level is tough. I can watch the price level and the market's reaction to it, but am unable to predict with certainty whether a bounce would happen or whether prices would just fall through. What I can try to do however, is assess my options and ask myself, IF a scenario happens, what would it lead to? What knock-on effects can I take advantage of? What would be a low-risk, high-probability and high-reward trade that I can take on?
This is the S&P500 crash or downtrend scenario and here are some of my thoughts.
*** If the S&P500 does crash this year or falls into a downtrend ***
I see a huge opportunity to make use of the artificially suppressed volatility in the SPY (the ETF that tracks the S&P500) to buy long-term out-of-the-money (OTM) put options, like the SPY Jan 15 '2016 170 Strike put option. This is a long-term bet and more of an "investment" rather than a trade. More on why OTM long-term put options below.
Some of us have read about the volatility index (VIX) being artificially suppressed. Meaning that someone is pumping in a lot of money to short the VIX, leading to artificially "low" volatility. From my POV, suppressed volatility means that it is cheaper to buy long-term options. In the event of a crash, the volatility will spike to an even greater extent, and again, increasing the value of your options in the event you wish to sell them or exercise them. Think of a spring-coil - the more you press it down, the harder it will spring back up. This knock-on effect is something to take advantage of.
From the chart posted above, you can see that I bought some cheap SPY Jan 2016 Put Options, and will continue to do so if and when the market rallies again. I have also sold a portion of them already. One part of my strategy is to sell off a portion of my options for relatively decent profits that should cover my option premium and continue to finance more put options at key levels, whether higher or lower. The key here is not to take profit too early when the market does move downward but always leaving a portion of the position open. The market tends to fall much harder than when it rises. Expect to see bigger downside moves in shorter periods of time.
Take note of the two price channels drawn above (drawn with blue lines, and with red lines). If and when the price of SPY falls below and breaks below the channel floor/support line and trades there for a sustained period of time, i.e., 3 to 4 days, we can expect to see an accelerated downside move that follows.
Continued in comments section...
ECB unveils €1.1tn QE plan to stimulate eurozone economy...
Larry Summers: The ECB's QE won't work...
The bubble will burst...
These are mixed sentiments that you might hear on the news and over the media. Many investors continued to buy into the all-time high in the S&P500 while other traders and investors that held a bearish view in U.S. equities last year were hurt by the continuing bullish S&P growth and threw in the towel trying to short the market. What probably hurt even more was that this growth was "stable" in the midst of escalating geopolitical tensions, poor economic news releases, outright war in certain countries, and questionably experimental central banking policies.
Where will the market go this year? What is the next price level on the S&P500 for it to hit on the upside? If there is a crash, how hard would it crash? What level should I get out at? Should I buy gold? Will Oil go back up?
The way I approach these questions to plan a trade or investment is less direct. Calling a market top or a market bottom or a specific price level is tough. I can watch the price level and the market's reaction to it, but am unable to predict with certainty whether a bounce would happen or whether prices would just fall through. What I can try to do however, is assess my options and ask myself, IF a scenario happens, what would it lead to? What knock-on effects can I take advantage of? What would be a low-risk, high-probability and high-reward trade that I can take on?
This is the S&P500 crash or downtrend scenario and here are some of my thoughts.
*** If the S&P500 does crash this year or falls into a downtrend ***
I see a huge opportunity to make use of the artificially suppressed volatility in the SPY (the ETF that tracks the S&P500) to buy long-term out-of-the-money (OTM) put options, like the SPY Jan 15 '2016 170 Strike put option. This is a long-term bet and more of an "investment" rather than a trade. More on why OTM long-term put options below.
Some of us have read about the volatility index (VIX) being artificially suppressed. Meaning that someone is pumping in a lot of money to short the VIX, leading to artificially "low" volatility. From my POV, suppressed volatility means that it is cheaper to buy long-term options. In the event of a crash, the volatility will spike to an even greater extent, and again, increasing the value of your options in the event you wish to sell them or exercise them. Think of a spring-coil - the more you press it down, the harder it will spring back up. This knock-on effect is something to take advantage of.
From the chart posted above, you can see that I bought some cheap SPY Jan 2016 Put Options, and will continue to do so if and when the market rallies again. I have also sold a portion of them already. One part of my strategy is to sell off a portion of my options for relatively decent profits that should cover my option premium and continue to finance more put options at key levels, whether higher or lower. The key here is not to take profit too early when the market does move downward but always leaving a portion of the position open. The market tends to fall much harder than when it rises. Expect to see bigger downside moves in shorter periods of time.
Take note of the two price channels drawn above (drawn with blue lines, and with red lines). If and when the price of SPY falls below and breaks below the channel floor/support line and trades there for a sustained period of time, i.e., 3 to 4 days, we can expect to see an accelerated downside move that follows.
Continued in comments section...