Detect and trade SPY significant up/down bias

[Luna Master]

Setup

SPY sits at $266.46 on MLK day – MON 01-21 and everyone is expecting market to go down after  3 weeks of climbing  straight up from the debts of 232 on WED 12-26.

Chronology

01-21 MON Detect that SPY FEB 255P ($1.56) is much more expensive than equidistant 275C ($0.94).  Rationale: general sentiment prevails  that a big correction is in the air  and market will re-test December lows.

01-22 TUE 09:30 Enter SPY vertical credit spread 5x(225-255P) and debit vertical spread 5x(275-280C) for a total credit of $222.90.  To add to suspense, SPY begins to slide to 265 and later to 264.

01-23 WE SPY continues to slide to 260 – was I wrong to bet against the market.  It is getting scary.

01-31 THU – SPY reached 269.51.  It is time to close the dangerous short leg of the trade.  I was able to close 225-255P for only $0.11 (or $69.10 with commissions).  Now, I only have long leg 275-280C that can only gain in value.

02-15 FRI – This is the last day before expiration, and SPY crosses above 275, bringing my 5xFEB275C into the money.  To protect sudden gains, I am exiting my long vertical spread 5xFEB275-280C for 1.77 (+$870.87).  What a halting, tire screeching trade!

SPY closes 277.37 on last day before expiration.  It means that I could have sold 275-280C spread for 277.37 – 275 = 2.37 and I sold for 1.77.  Loss of about 0.60 ( or $300) is well worth several hours of tranquility and the confidence of making a good trade.

 

Lessons Learned

This was a story trade.  I felt that market will continue to raise, while prevailing sentiment was an expectation of a pull back.

This is the first time I examined and traded the sentiment.  I would measure it by dividing more expensive put (1.56)  by less expensive call (0.94) and get 1.65. Normally, you would expect a number to be much close to 1. With such a pronounced skew, you can sell put and buy call for a credit, and this credit will be large enough to buy a protection on put side.  To bring even more money in, I would sell further OTM call, but this is optional, because they will bring very little.

 

[Author]

Posts