SPY PUT Options (SPDR 500 ETF) And Hedging With Options In A Lackluster Market

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The SPY PUT (SPDR 500 ETF) remains my favorite method of Hedging With Options. This present correction which is now into its fourth month has worked very well for my SPY PUT Hedge. In this correction to date, the stock market was down about 10% at its worst. Meanwhile my SPDR 500 ETF hedge or Spy Put Hedge is now covering 3.6% of my total portfolio. In other words my hedging with options strategy using the spy put options has earned $27930.00 against my entire portfolio of $772,916.00. In past years the Spy Put Hedge has earned more as a percentage of the entire portfolio during corrections. This shows that the present market correction despite all the wailing among analysts and media pundits has not been all that severe and remains a correction in a bull market.

Spy Put (SPDR 500 ETF 500 ETF) Trade for July 12

On Thursday I did two SPY PUT trades. Both were successful trades but the important aspect of these spy put trades was to understand the reasons for not holding the spy put options overnight going into Friday or holding any spy put contracts overnight any day over the past few trading sessions.

To understand the value of using the Spy Put as a method of hedging with options investors need to understand that the SPY Put hedge is meant to benefit from down markets and down days. In other words, while the overall direction may be lower for a given period of time, whether it be a few days, a week or a month, as an investor it is important to realize that you want to stack the odds of the spy put trade being consistently profitable in your favor. To do that you need to keep an eye on the direction the market has headed and to realize that most often holding the spy put options overnight is a poor choice unless the market direction is solidly lower day after day.

I get asked repeated why my spy put trades are consistently profitable. I answer the same every time. I am trading with the market direction trend. When you are hedging with options an entire portfolio, the market direction is what guarantees profit or loss with the spy put hedge.

S&P 500 Index Chart July 5 to July 12 2012

Below is the 30 minute S&P 500 Index chart for July 5 to July 12 2012 and while the overall direction for most of the period was lower, as an investor you need to actually study the daily trends to be consistently profitable with the SPY Put Hedge trades. By quickly reviewing each day I knew that holding spy put contracts overnight in this period could end up with some losses. In order for the spy put hedge to work consistently there must be consistent selling among investors and a reoccurring weakness that lends itself to pushing the market direction lower. In the period from July 5 to present, there is no such selling pressure but instead a lackluster market which could turn on any bit of news or could have a technical bounce higher. This is a dangerous type of market for holding spy put options overnight and you can tell from my recent trades that I have done very few spy put trades over the past few days. There is a reason my spy put trades are consistently profitable. I never over trade and I stay away from lackluster markets. Here is what I looked at each day.

Spy Put Trades July 5 to 12 2012

The market direction while lower reflects a lack of selling on the part of most investors.

A. July 5. The market gapped down at the open and in the first 30 minutes it fell to 1365.59. But the trend for the rest of the day was higher and the market closed at 1367.55. Basically the market closed near the lows of the day but not lower than the gap down. Another sideways or lackluster day.

B. July 6. The market opened with a larger gap down on the employment numbers. The low for the first half hour was 1353.29. The S&P 500 Index moved a bit lower but in the end it closed at 1354.68. Again almost unchanged from the morning gap down. Both of these days show that strength remains within the market. While investors have limited conviction about buying stocks they have less interest in selling their stocks. The market is basically telling investors that day and swing traders are in the market and investors are playing a waiting game.

C. July 9. Monday was an interesting day. A small gap down in the morning saw a low of 1348.89. The market did very little and closed at 1350.05. Again almost unchanged. After three days you can see that the market direction while lower is actually being determined by day and swing traders. They are trading stocks for small gains here and there. The overall market direction is not their concern. Instead they are trading individual stocks which is exactly what other investors should be considering and what I have done as well. After three days there remains enough strength in the market to tell me that I should not consider holding spy put contracts overnight. When Hedging With Options using the spy put, I must see consistent profits because I am trading for small gains. The lackluster market means small gains at best and the risk if losses, even small ones, makes doing spy put options trades questionable in this type of market. A gradual decline in the market direction and often ends up like an elastic band. Every day the band stretches a bit more and at some point it will bounce back. I do not want to be holding spy put contracts when the bounce back occurs. To avoid this it is better to use the Ultimate Oscillator and spot daily overbought conditions to time buying the spy put contracts and then oversold conditions to sell my spy put contracts but only on days that are definitely down. Lackluster type days can swing either way.

D. July 10. I missed the move lower on July 10 as I was away for some of the day. July 10 offered the best down day for the SPY Put Hedge for the week.

E. July 11. By now the market has been down 4 days in a row and while my market timing indicators in my market direction/ market timing column for that day showed the bias is still lower, 4 down days is normally a short-term market bottom. On July 11 the market opened up and ran up slightly. The low for the first half hour was 1339.22. The market closed at 1341.45 again just slightly higher than the first 30 minutes low.

F. July 12. I did two trades on July 12 but the gap down in the morning and then the snap back were clear signs that the market direction was going to push back up. The low within the first half hour was 1327.14 and the close was 1334.76. However while both trades were successful, the second spy put trade earned just slightly more than $100.00 as I closed it before the market close. I did this because most of the day was spent with the S&P 500 Index moving higher, despite the selling at the close. And the close for the first time was not just slightly higher, but higher despite the selling at the close.

Don’t Over Trade The Spy Put Options

In order to hold spy put options overnight the market direction must be solidly lower. Throughout the past 6 trading sessions while the trend was gradually lower, the move down was continually being met with a solid close and in most days the close was always just slightly above the first half hour low. Why trade the Spy Put Options for a hundred dollars here and there when the risk of loss is higher. In investing you want to be consistently profitable. That means do not over trade the Spy Put Options. Trade on strong down days when even a poorly timed spy put purchase still has a good chance of being profitable. Patience is important when hedging with options. You need the right conditions. When the direction is a definite down, the profits are so enormous that it makes having patience worthwhile.

Let’s look at why waiting for the right conditions is worthwhile instead of trading for a hundred dollars here and there and risking losses.

Hedging With Options July 25 To August 8 2011

To hold SPY PUT Options overnight I need the market direction to be solidly lower. Each day should see the market direction continually moving lower and the volume in the market climbing as the market direction keeps falling. This type of chart shows why Hedging With Options can be very profitable. Last year just before the waterfall decline in the chart below my SPY PUT HEDGE was at $21,174.50.  By August 9 the Spy Put Hedge had mushroomed by 140.5% over a period of 11 days to $50,941.00.

Making these kinds of returns needs just a few things to be in place. They include proper market direction and climbing volume as investors become worried. This type of return should tell investors that risking capital during periods when conditions are not aligned to guarantee consistent profits are not worthwhile.

Hedging With Options

Hedging with Options using the spy put requires patience and the right market direction. The pullback of July 25 to August 8 earned a 140% return over just 11 days.

Recent S&P 500 Index Market Pullback

The recent pullback from July 5 to July 12 was just 2.3% with lackluster volume. If I add in Friday’s gain, the decline is just 1.2% These are not the types of declines to hold SPY Put options contracts overnight. As you can also tell from my spy put trades during this period, they are rarely days worth trading. For my capital to compound and my strategy of hedging with options my portfolio I need consistent profitable trades. Trading in an environment where the odds of every trade being profitable are not stacked in my favor is never worthwhile.

Spy Put Hedge July 5 to July 12

Lackluster days are not prime days for the spy put hedge to perform consistently.

Last Word On Holding Spy Put Contracts Overnight

You can tell that holding SPY Put Contracts overnight is a poor choice unless the direction in the market is solidly down. When hedging with options through the Spy Put Contracts, it pays to remember that watching the 30 minute charts and plotting them each day can assist in understanding whether or not the market direction down is strong enough to warrant holding spy put contracts longer than a day. Many lackluster days open with a gap down and trend sideways. These are not optimum days for spy put profits large enough to warrant the risk of losses no matter how small. Being wrong once or twice a month will erode consistent profits and is a detriment to the goal of using the spy put options as a way to build a hedge to protect against market corrections.


Internal References

Listing Of SPY PUT Trade Articles

2012 SPY PUT Trades Listing

2011 SPY PUT Trades Listing

2010 SPY PUT Trades Listing

Articles Discussing The Ultimate Oscillator

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)

External References

SPY PUT Option Chain
SPY ETF Home Page From State Street Global Advisors (SPDR)