Some of the biggest and quickest rallies occur during corrections or bear markets. This makes selling or getting short a treacherous prospect.
One approach I’m using is to sell out-of-the money call spreads for credit.
By waiting until a stock or index has rallied into a resistance level the bear call spread provides not only a price cushion but also benefits from time decay.
We’ve discussed we don’t believe a sustainable bottom won’t happen until we have some type of ‘whoosh” of selling panic in which people are in a “get me out at any price” state of mind accompanied by VIX spiking above the 30 level.
We’ve been teased a few times as we’ve had a couple of days with the major indices down some 2% intraday only to close up near unchanged. Those have been tempting days to go bottom fishing.
The most tempting occurred early on early this week; last Friday saw the S&P 500 and Nasdaq 100 surged some 2% following what had been a near 3% plunge on Thursday that also saw the VIX touch the (not so magical) 30 level. That’s one box checked for finding a bottom.
On Monday we had a solid follow through, first consecutive up day since February 20th. What’s more a “90/90” day, meaning 90% of volume was up and breadth was 90% positive. Historically 90/90 days have proved powerful signals for further follow through. So yet another box checked for those looking for a bottom.
But we still need to keep in mind the dominant trend is down; not only are the major indices below their 200 day moving averages but so are the majority of individual stocks. Meaning it’s not just the “Lag 7” that have been giving up their ill gotten gains.
On Wednesday the SPY rallied right to its 200 dma, which also coincides with the November election gap that represents horizontal resistance.
This seemed a good spot to add some bearish leaning exposure through a call credit spread.
I sent this Alert to members of the on Wednesday afternoon:
THIS TRADE IS NOW CLOSED.
SPY ($570.20) certainly looks like it’s bottoming. But the 200 dma looms above at $572.80 which coincides with the horizontal resistance.
But I think with the April 2 tariff decree still looming, and whatever daily tweets might occur, the upside should be limited. A “v” bottom does not seem in the cards.
Let’s make use of elevated implied volatility to sell an out-of-the money call spread.
ACTION:
-Sell to open 2 contracts Mar (3/25) 577 Calls
-Buy to open 2 contracts Mar (3/25) 581 Calls
For a Net Credit of $0.95 (+/-0.10)
My risk management for this trade will be to exit if SPY closes above its 200 dma, currently around $573.40. Which is still below the 577 short strike; meaning even if SPY rallies a bit in the next few days the position has a good probability of delivering a profit through time decay.
THIS TRADE CLOSED FOR AN 89% WIN ON FRIDAY, MARCH 21st.
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