timwest
Long

S&P500 SPY YEAR-END OPTIONS GRAPHED

AMEX:SPY   SPDR S&P 500
With the S&P500             ($SPY) at 215.04 last as of Friday, October 7, 2016, you can see the price of various options.

I started at 215 which is "at the money" and the prices above that are the call options, since those are "out of the money". I made the call options green, since they are for upside price action. I then graphed the put options prices from 215 and down and made them red, since they are for downside price action.

What you can see is that it costs a lot more to protect against a market decline than it does for a rally. In fact, if you had $1.65-$1.70 to spend on a CALL option, you could get one that was 3.2% out of the money. But if you bought a PUT option instead, you'd have to get one that was 9.3% out of the money, which is ALMOST 3 TIMES FURTHER OUT OF THE MONEY.

Basically speaking you'd have to monitor this every day to see what was a "normal" amount of skew, or price difference between puts and calls that are out of the money. But I think you can see that this is a pretty extreme reading at first glance. The fact that they are different in price is more of a function of how people use options and who initiates the trade to price the option.

Let's walk through the basics:
A put buyer enters an order to buy a put, which gives a put seller the chance to sell. Once the transaction has occurred, the "put seller" generally would prefer to neutralize the position by either selling short a fractional amount of the index, or go out and purchase other put options to hedge off the risk. So after awhile, a market for options that looks like this would imply that a lot of hedging has taken place and nervous longs and bearish speculators have already built their positions and are protected against a market decline. What I would also expect out of an extreme reading like we have now, is that any sharp decline would find a bottom quickly because the hedges are already in place. This is not to say that we can't have any declines, but you wouldn't expect to see a cascading decline or a massive collapse with this much hedging already in place.

It looks to me that the market will more likely edge higher to the 220-225 area into year end as a much more likely possibility to the 198-206 area. The odds are better than 2:1 that this is true, from the way that I see it.

Have a great weekend and hope to continue doing this analysis each weekend until it shows a bearish signal.

I'll be in KEY HIDDEN LEVELS chat room during the week if you have any questions or feel free, of course, to post questions here.

All the best,

Tim
Comment: November 29, 2016 UPDATE WITH SPY AT 220.91
If you pay about 0.9% premium on either side, calls are half the distance from the market. Whereas before it was one-third the distance. Down-spikes find support when put premiums are expensive. The next level is to look for open interest and see if there are any high open interest levels.
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I have just started to play the uncovered SPY Call Sells (OTM) and SPY PUT Sells (OTM) to make some weekly income and it is working out OK. I have not figured out a few key things like 'best day to do this during the week', 'how far to go OTM', 'when to close it out' (or let it expire), 'when to play SPY vs QQQ for the same strategy', and 'why not play both' (candle burning at both ends makes the room brighter but could also burn hands)!
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timwest PRO kenny1924
@kenny1924, We often call that "Picking up pennies from the railroad track". If you sell "spreads" and not "outright shorts", you stand a chance at surviving the unexpected. The unexpected large move down out of nowhere has happened about 10 times in 30 years, and those can put a real dent in your principal. My suggestion is to use "spreads" to define your losses up front.
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kenny1924 timwest
@timwest, Yes, I am planning to start doing that, although that gets me deeper into option plays as opposed to doing the covered call and naked puts. We will start to see the higher volatility come into play soon and we definitely need to be ready for that. For indices, it does make a lot of sense to play the "spreads" since the picture can change any morning. Thanks for the suggestion.
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can you give an example of the 0.9% premium? do you mean the equivalent to a 1% move of spy? the ATM straddle?
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how is it looking now? $SKEW is still slightly bearish, maybe almost neutral now. possible trading range until inauguration, if he makes it alive until then.
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@Reekardo, indeed.
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Reekardo IvanLabrie
@IvanLabrie, seller failure today... thats bad for bears. open range resets on thursday on SPX. confirm on friday if december is bearish or bullish.
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timwest PRO Reekardo
@Reekardo, I'll update the graph and see how it looks. When this graph was made the election and earnings were foremost in our minds with all of the associated nervousness. Now that's gone. You can see why this was "constructive" to have options priced this way with this much skew.
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Reekardo timwest
@timwest, sure feels like they want everything under 2200 expire worthless until december opex. lets see how open range sets on DEC 1st and what direction this goes after that. something tells me they are going to go for the quarterly pivot resistance 2216 on spx cash. if they tag that, then 2230 and 2265 are in play.
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This is getting out of hand:

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