This August has been my most passive month for trades since I started trading options more than a decade ago. Today’s trade was only my second trade for the month and doubt I’ll make a trade tomorrow, the final trading day of the month. The driving force in my wait-and-see attitude came from slump since the S&P 500’s peak on August 5th. I was growing more bearish before then and once the market started heading south, I couldn’t find a solid reason to make another bullish trade. Since I think we’re still in a long-term bull market, I didn’t want to make any bearish trades that might backfire on me in a reversal. Yesterday, I started wondering if it was a good time to start nibbling in deeper again. By the time the market closed yesterday, I figured out what I thought my trade would be.
This morning’s intraday low was 4.42% below the intraday high on SPY since August 2nd and August 5th. Yesterday’s low was slightly lower at 4.62% below the August (and all time) intraday high. I don’t think we’re headed into another bear market yet, but am also not sure if we’re about to see a rebound or if we might get another few percent lower before we recover. Rather than attempting to catch an exact bottom of the day, I didn’t place my order until after the market opened today. I wanted to see if the opening would dip again to help me on the premiums before I increased my exposure. SPY did open lower, but immediately moved higher. It took me a few minutes to commit to the order, but finally had it trigger while it was up $0.60 from its low 12 minutes earlier. While SPY was trading at $164.00, I sold one SPY November $160 naked put for $3.50 and received $349.70 after paying only $0.30 in commission.
I chose this strike because I wanted some upside mixed with a little extra buffer before I accept any losses. With the ETF down nearly 4.5% already and the extra cushion from selling out-of-the-money in addition to the premium I received, I’m giving myself a great entry point, even if we have already started to head into an unforeseen bear market. If I’m assigned these 100 shares, I’ll be buying in while SPY is down 8.46% from its high. I thought about giving myself even more cushion, but I wanted the reward to be at least 10%, i.e. I wanted the trade to be worth the effort. I was able to get a potential 10.2% annualized gain by going out to November for the expiration. SPY could move below my strike and back up by then.
The June low was at $155.74 for SPY. My cost per share will be $156.50 if assigned. I look at that buy-in price as a fairly safe trade. I could lose in the short term, but over a long enough period, buying close to 8.50% below a high has never lost on SPY. In fact, this area, around 4.5-6% off a high for an index, is where I like to sell more puts. Volatility has woken up a bit and I’ve missed the first few percent of losses that can be within a normal trading channel for an index. I’ll continue to sell farther out-of-the-money puts as long as the indexes are below their 10-day moving averages. SPY has crossed its 100-day moving average in each of the past three days. That doesn’t make me bullish, but the pause in the slide helped me break my cautionary stance with a slightly lower probability of assignment trade. Once SPY pulls above its 10-dma, I’ll probably aim for closer-to-the-money trades. IWM (small cap ETF) is starting to make that transition, but I already have puts less than 2% out-of-the-money in addition to the UWM (leveraged small cap ETF) puts I’m short. Since I’m already more than 100% invested, I might have to close some other puts before selling any new ones. I won’t opt to close the other puts if I see the broader indexes start making a true recovery.
SPY Naked Put Risk/Reward Breakdown
Potential profit: $349.50
Potential return: 2.23%, 10.2% annualized
Breakeven price: $156.50
Downside protection: 4.57%
Recent high: $170.96 on 8/2/13 and 8/5/13
Cushion from recent high: 8.46%
Expected support: $163.00, then $160.22, then $156.21 (along with the rising 200-dma)
Position close goal/limit: Plan to stick with it through expiration and take assignment for long-term hold. My cost should be low enough that I can manage the position with covered calls if I have to.