When stock markets open with a big gap down, the trend is almost inevitably set for the day. Trading big gap downs with the SPY PUT is almost always easier than investors realize. Gap downs just like gap ups are periods when the market pessimism or optimism is such that stocks open significantly lower or higher than the previous day’s close. This morning’s earnings from the likes of Dupont following yesterday’s Caterpillar’s earnings were bad enough to push the stock markets to open significantly lower than yesterday’s close. A lot of investors look at the gap down and think “wish i had bought puts yesterday”. When it comes to stocks, hindsight is pointless. But this does not mean I cannot benefit from the big gap down since now I know the Stock Market Direction. I always turn to my SPY PUT options. The SPY PUT options have been my favorite method of hedging my entire portfolio since they were first introduced back in 1993.
Market Direction At The Open
At the open this morning the market direction was a big gap down. But almost always there will be a small rally as investors love to buy the gap open, whether up or down. With the big gap down this morning, investors wait a minute or two and then buy for what they hope will be a quick trade higher. They push up stocks and create an overbought indicator in the Ultimate Oscillator.
If you recall my article 4 Steps to Success with trading the SPY PUT from this past weekend, you know that the Ultimate Oscillator is my timing tool to buy and sell Spy Puts.
I always wait after a big gap down open and look for that little push back by traders.
Let’s look at this morning’s open. The gap down open is clear but buying at this point could be a big mistake as I can’t be sure that the gap down will continue or will in fact bounce back higher. I wait for that first oversold signal (green in the chart above) and then the rally back.
In the rally back I buy with the overbought signal. In the case above I bought in at 9:51 but I could have waited as the S&P did push a bit higher.
Selling The SPY PUT OPTIONS
Then I wait for the market to fall lower than the open. In the chart below I have marked the steps from this morning’s trade.
I bought my SPY PUT Options contracts on the little rally back after the open with the overbought signal from the Ultimate Oscillator. I bought 40 SPY PUT options contracts because this is a big gap down. The trend is clearly lower for today. This is the type of day to buy big quantities of put options on the SPDR 500 ETF.
The second low (first after I bought my SPY PUT contracts) is not much lower than the first and the oversold indicator is minimal, meaning more downside could be ahead. This is a big down day and there should be a lower low. The next low signal (marked 2) is again not much lower than the 1st, but the 3rd (marked 3) is a lot better than the first.
I sold my spy puts as the signal waned and the S&P 500 tried to climb back slightly.
Afternoon Sell Off and SPY PUT Options
Once that sell of my SPY PUT options takes place I almost always wait to see if we are going to get that lunch hour rally. Sometimes the rally extends into the afternoon until perhaps 2 PM as traders duel it out for day trading profits. I look for the afternoon overbought indicators and eventually I usually pick up more spy puts on big down days like today. It is almost always a case of selling into or near the close. We will have to see how the afternoon trades. You can check out today’s morning trade by selecting this link and scrolling to Oct 23 in the chart.
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)