The recent rallies in Crude Oil and Stocks have completely cleared out the short-term memories of many traders. While an article of mine from just two days ago indicated that those with cash on the sidelines might put some of it to work, the rally of the last two days may provide an opportunity for pause. Like all commodities, including Crude Oil, the Stock Market, as represented by the E-mini S&P has a tendency to trade with hyperbole and cause the casual observer to believe that there is no rhyme or reason to its movement. When too much money is following a trend, there seems to be a reversion to the mean. While this is a pretty general comment, make note that trends can be very difficult to find and many traders end up getting long or short at the end of the move.
Since February 11th, Crude Oil, as represented by the July Futures Contract, the E-mini S&P (June 2016 Contract) have appreciated considerably. The Table below shows the gains in the contracts since both the end of the year and February 11th. The Gold (June 2016 Contract) has gained considerably since the end of the year, but not since the February panic. The movement of these contracts is tremendous and shows that all three asset classes have shown considerable growth. Crude Oil’s move of greater than 42% since February is quite amazing. Commodities frequently have large moves, but Crude Oil has not yet reached its trading levels of last November and December. In addition, it is trading significantly below its yearly high of $63.
While the E-mini S&P is only showing gains of just over 2.75% for the year, its increase from the February 11th close is impressive. In order to take advantage of the recent rally in Stocks and perhaps Crude Oil without the edge, there is a strategy which, particularly in the E-mini S&P and SPY (SPDR S&P 500 Trust ETF), provide a limited risk Options Position to Hedge Risk or get Short the Market. The Strategy may come in handy as the E-mini S&P approaches resistance at 2100. Here’s why it provides good value and how it works:
- It takes advantage of the Implied Volatility Skew to capture an Implied Volatility advantage on each leg of the trade
- Gets the Trader Short by Selling an out-of-the money Call Spread
- Gets the Trader Short by Buying an out-of-the money Put Spread
- Provides limited risk with Profit and Loss Pre-defined
- Provides tremendous flexibility to get Short the market at a level that makes sense to you. The Current Trading Level may not be the level for you to initiate this Short Position, but the strategy provides room for additional upside gains before experiencing losses.
The Table below provides all of the characteristics of the Strategy. As you can see, although we Sell a Call Spread equidistant from the current trading price as the Put Spread we Buy, we collect money to get short. The risk/reward ratio is excellent. Comparatively, if you were to Buy out-of-the money Puts and Sell out-of-the money Calls equidistant from the current trading price you would have a large debit. For those of you who have difficulty with any of these concepts, or are trying to improve your Options Trading Skills: Try a sample of our Options Trading Webinars; they can improve your trading technique. Whenever you trade Options Contracts, be sure to evaluate Liquidity, Historical and Implied Volatility, the Implied Volatility Skew and the appropriate Options Trading Strategy to meet your goals. We can’t put enough emphasis on these critical elements. Our Webinar Preview PDF may be helpful.
