In the last several weeks, I have been growing more and more concerned with the market. I had a hunch that the market was due for a fall, and so I added S&P 500 ETF (SPY) put options to my Cabot Options Trader portfolio.
What did I see that had me concerned about the market?
Earnings season was turning into a mess. Companies that beat earnings were rewarded with small share price gains. Companies that met expectations, saw their shares fall a couple percent. And if a company missed expectations, the selling would often drive these stocks down 10%-20%. Here is a small list of those stocks that got punished.
Applied Optoelectronics (AAOI) down 33%
Unisys (UIS) down 29%
Coherent (COHR) down 20%
Ultimate Software (ULTI) down 14%
Teva Pharmaceutical (TEVA) down 36%
Good news was no longer being rewarded. And bad news was punished brutally. This was my first warning sign.
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My second big concern was the lack of conviction in options trading. For weeks, the big market players had been quiet. No longer were they buying high conviction calls in market titans such as Facebook (FB) and Goldman Sachs (GS). Instead, what little option activity my unusual option scanner was picking up on was targeting earnings plays. And when the market is strong, options traders usually load up on calls, so the silent activity was notable.
And lastly, while the headlines read “Dow All-Time Highs”, I knew that most of the market was in fact not moving, and in many respects, was actually weakening. And I told my readers several times, I could feel that under the surface, the sellers were potentially taking over, as “risk on” sectors such as Semiconductors (SMH), Biotech (IBB) and the Russell 2000 (IWM) were under pressure.
These three inputs combined had me concerned.
Now was I so sure that the market was going to fall that I jumped wildly onto the short side, and sold all my bullish positions? No. I am never so sure of myself that I go all-in. Instead, I wasn’t adding more bullish positions to the portfolio, even as the headlines read “New All-Time Highs!”
And given my concerns, and with the Chicago Board of Options Exchange Volatility Index (VIX) at all-time lows, the price of buying put options, betting the market would go lower, was too good to pass up.
Here was the trade alert I sent to my Cabot Options Trader readers on Friday, August 4, just days before the market fell, detailing my thoughts on the state of the market, and why we were buying put options.
Buy S&P 500 ETF (SPY) January 240 Puts (exp. 1/2018) for $5.50 or less.
The market is in an interesting spot.
The Dow seems to make new highs every day, the long-term trend is clearly up, and every time there’s a negative headline from Washington D.C. or globally, the bulls immediately buy the shallow dips. This is clearly bullish.
However, below the surface, a lot of stocks have been struggling recently. The Russell 2000 (IWM), Semiconductors (SMH) and Biotechs (XBI), which are considered “risk on,” are all losing steam. The list of stocks that have fallen by 10% to 20% on earnings in the last two weeks is extremely long. And the list of stocks that blew away earnings, yet fell, is also growing. At least for now, good news is not being rewarded, and bad news is getting punished.
With the VIX again below 10, the price is again just too good to pass up for portfolio insurance for the next 168 days.
To execute this trade, you need to:
Buy to Open the SPY January 240 Puts.
As is always the case when I send a trade alert, I give a price that is easily achievable for my readers. And we were filled on that put buy at $5.31.
The following Tuesday the S&P 500 made a new all-time high, but then reversed to close lower on the day. And then, a couple days later, the S&P and Nasdaq fell by 1.45% and 2.13%, respectively.
The next day, Friday, five trading days after our put purchase, I sent this trade alert, selling half of our puts for a quick 35% profit.
Sell Half of Existing Position: Sell HALF your S&P 500 ETF (SPY) January 240 Puts for $7.20 or more.
The S&P 500 fell by 1.4% yesterday, and the Nasdaq dropped 2.13%. And with that market drop, the VIX soared 44%.
I am going to sell half of my hedge today.
To execute this trade you need to:
Sell to Close HALF your SPY January 240 Puts.
What comes next for the market in the coming days is anyone’s guess. However, for now, I am going to hold half of my put options. And as always, I will be watching option order flow, as well as the strength in leading sectors, to give me my next cue.
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Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.Learn More