The SPDR 500 ETF as regular readers know is my preferred method of hedging my portfolio through using SPY PUT Options. There are certainly lots of other methods particularly with the Ultra Short products like SDS and TZA to profit in a downturn. I use the SPY PUT options because they are very liquid and after studying them back in 1993 when they first arrived on the scene and paper trading them for almost a year I found that not only was the likelihood of profit very good, but the level of losses extremely small as long as I stayed with the trend.
SPY PUT and Trend Following
I only use the SPY PUT on days when there is no doubt that the trend is down. For example the chart below shows the down days in the S&P 500 over the past month that I have traded the SPY PUT Options against. Of all the days I have traded in the last month you can see that all but 1 were large down days. Oct 12 while not a large down day was definitely down and had a wide range on that day making the SPY PUT hedge easy to place and manage.
I get a lot of emails asking me how do you do this. How can I keep getting so many winning trades with the SPY PUT. I keep sending the same replies. The SPY PUT hedge works because I only trade it on down days and I only buy on clear overbought signals from the Ultimate Oscillator. For example the trade below is for Friday Oct 19, a huge down day for the S&P 500 and all the indexes.
Here are the 4 steps I followed to make sure the SPY PUT trade for Oct 19 would be successful.
SPY PUT Trade – Oct 29 2012
Step 1: I brought up the SPX chart and set it for 1 minute.
Step 1: I open the Ultimate Oscillator and set it for the settings you see below:
Step 3: I wait for the overbought signal from the Ultimate Oscillator and look for a downturn in the S&P 500 after seeing the Ultimate Oscillator overbought signal. On Friday Oct 19 at 10:00 AM I received the first solid overbought signal. I waited a minute and saw no more upside pressure and bought the SPY PUT option contracts. I go out at least 1 month but often 2 months and I stay at the money.
If the trend continues to rise and I think I am wrong I close immediately. However when the overall trend is down I can almost be assured that the trade will work out even if the S&P should climb slightly above where I bought my SPY PUT options contracts.
Step 4: I wait for the oversold signal from the Ultimate Oscillator and decide whether to sell at the first signal or whether the day’s trend down is strong enought that I will hold a bit longer. On Friday Oct 19 I held for a while because the trend was definitely bearish.
But I could have sold at any of the oversold signals and made a profit. After doing this strategy since 1993 I have developed a bit of an instinct that tells me when to stay in longer. As well I am always with the trend. The trend is lower on a day like Oct 19 as volumes are higher than usual, the VIX is climbing, and if I turn on MSNBC all the talk is bearish.
On the chart below I have three different arrows on the oversold indicators. The first 3 are blue arrows and they depict smaller profit potentials but the oversold indicator is not quite what I am looking for. The next 3 are green arrows and they are far more profitable. As well the oversold indicators are stronger and last much longer as the S&P 500 continues to fall under heavy pressure. The red arrow is where I sold after the third large oversold signal.
That’s it. That’s the 4 steps I use. The rest is mainly watching the indexes and keeping an eye that the trend lower remains intact.
Spy Put Options Market Panic Tips
1) During market panics like in the fall of 2008, this strategy is easier because I normally buy my spy puts right near the open on the very first overbought signal as there is often a short bounce at the open and then the market moves lower. This is because the market is in full panic mode and the trend on those days is definitely lower.
2) I usually buy larger quantities such as 50 or 60 SPY PUT options contracts because there is no doubt the trend is lower.
3) I usually sell them in groups on oversold signals but I wait for heavier signals such as the green arrows above. I then watch the S&P 1 minute chart for any signs that there could be a large bounce. In a market panic there are very large bounces. By selling in groups of perhaps 20 SPY PUT options contracts at a time I can often catch better returns overall since the market swings in a panic are much bigger.
4) I never ever buy SPY PUT option contracts when there is no overbought signal. Buying at the wrong time in a market panic can wipe out a lot of earnings.
Spy Put Options Hedge Summary for Oct 19 2012
I did more volume on October 19 by stepping up from 20 SPY PUT options contracts to 30. I did contemplate buying 40 or splitting the buy and buying 20 SPY PUT options contracts at 10:00 and then perhaps another 20 at 10:05 for example. However I felt that while the mood was lower my short term market timing technical readings as per my market direction outlook for Friday didn’t really show much downside other than the possibility that Friday being options expiration, we could see some swings, but certainly nothing like what the market ended up doing on Friday.
To conclude then, it is important to remember that betting against the trend on days that are not really down is just asking for losses. I have very few losses but then I trade the SPY PUT options only on confirmed down days.
SPY PUT OPTION LINKS
Understanding SPY PUT Hedge Strategy Part 1
(When I Can Watch The Market During The Day)
Understanding SPY PUT Hedge Strategy Part 2
(When I Am Unable To Watch The Market)
Understanding SPY PUT Hedge Strategy Part 3
(Short version using only ultimate oscillator)