During the entire month of August, the stock market basically did nothing. It’s been up, it’s been down, but really hasn’t gone anywhere. The S&P 500 is in the same place now as it was back in July. What do you do when a market doesn’t want to go anywhere? You strangle it!
An options position that I’ve been recommending in the past few weeks to my clients involves selling strangles on the November E-mini S&P 500 futures. This position basically makes money if the market stays within a specified range.
Now a lot of market commentators would like you to believe that the market has made gains and could continue making gains because crude oil is now cheaper. However, if you overlay a crude oil chart over an S&P chart, you’ll see this doesn’t make sense. Sometimes crude oil falls along with the market. They don’t always have an inverse relationship.
Because there are so many mixed signals in the market right now, some good, and some bad, I think the market will continue sideways during the next two months. Try to keep the big picture in mind instead of looking at each and every detail of every report. The day-to-day reports are sometimes just market noise. Selling a strangle can help you keep the big picture in mind.
Trade Recommendation: Selling Strangles
Here are the specifics of the options strategy. I’m recommending selling strangles on the November E-mini S&P 500 options. I would recommend selling one 1350 call option and one sell 1170 put option. These options expire on November 21, although I wouldn’t recommend holding the position all the way to expiration. We have about 2-½ months until expiration.
Remember, you’re selling a call and selling a put. Therefore you would be bringing in a certain amount of premium, at the time of this writing that would be about 40 points. This would bring $2,000 in premium ($50 for each point).
This strangle gives you a range of 180 points (1350 – 1170 = 180). In this kind of position you would want the market to stay between 1170 and below 1350. If you feel the market will stay in this range during the next 4-6 weeks, this could be a potential trade for you.
There are two breakeven points in this trade. You can find these by taking your premium, in this example 40 points, and adding it to call option strike (1350). This gives you a breakeven of 1390 on the high end. If the market turns lower, you find your breakeven point by subtracting the premium of 40 points from the put option strike (1170) to give you 1130. If we disregard commissions, this example trade would make money anywhere between 1130 and 1350 at expiration. If the S&P trades outside of this range at expiration, the position would lose money. This gives us about 200 points of room for market fluctuations.
No we don’t have to keep the entire premium for this trade to be successful. If we could hold onto 60-70 percent of the premium that would still be considered a success.
Margin for a position like this is about $2,500 and is considered span-margin, since the exchange recognizes the two option trades as a single position. This doesn’t mean that you should have an account with just $2,500. If you are trading in the futures or options market, you need to have some cushion to absorb potential losses.
S&P 500 Market Movements
Let’s look at this past year’s movements in the S&P. As you can see in the chart below, the market traded near 1478 at the beginning of the year. The S&P 500 is currently near 1242. Over the last eight months, S&P futures are down about 200 points. Divide 200 by eight months and we get an average loss of about 25 each month.
Over the last 30 days, not much of a change has happened, but if you look at other months, the S&P is capable of dropping 100 points in a month, as it did during this past summer. This can be a pretty dramatic drop. And if it happens again, you have to be able to adjust your trades.
The nice thing about selling strangles is that the position can be easily adjusted. We can re-bracket the position if it doesn’t go our way, or just exit if market conditions change. The biggest advantage in selling a strangle is that the market cannot be in two place at once. You are not trying to pick direction in this trade. You are only hoping it stays within a range.
However, keep in mind that this trade involves selling options which by definition exposes you to unlimited risk. This is why it is a good idea to watch this position constantly so that you are prepared to either adjust or exit your position should the market make an unexpected move. This is part of what I do for my clients. I watch the markets for them and give them recommendations if adjustments should be made. Feel free to give me a call at 800-798-7671 if you would like more specific recommendations, since prices are changing daily.
I think the market will continue to go sideways. And keep in mind the market has fallen on average of about 25 points per month this year. This position creates a range of about 200 points, so it definitely gives a trader some breathing room.
I don’t believe the Federal Reserve will raise or lower rates any time soon. I don’t think interest rates will be raised until the beginning of next year. The U.S. presidential elections are the wild card, so it will be interesting to see how the markets react to the newly elected President.
There are some good things in the market, but they can also be viewed negatively. For example, the U.S. dollar has gotten much stronger this summer, which is generally viewed as positive for the economy. However, the most recent GDP growth was heavily due to a big jump in exports due to a weak dollar. Now that it is stronger, that export-driven demand may fizzle away, and the GDP could turn lower. So there are two sides to every issue.
My overall view of the economy is that things will continue to get worse before they get better. There are still housing problems despite many predictions last year that it would be over by mid-2008. That hasn’t happened. Money hasn’t been flowing as it used to be. Banks are being very tight with their credit and there are no signs of that letting up anytime soon. In real estate, it’s a buyer’s market in many parts of the country, but there aren’t enough buyers because credit standards are now much higher. All of this is keeping the market under pressure and I wouldn’t strongly positive market development for at least another year.
Michael Sabo is a Senior Market Strategist with Lind Plus. He can be reached at 800-798-7671 or via email at msabo@lind-waldock.com.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
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