Warning: Read This Before You Buy Another Stock
Despite the recent rally, things are not looking good for stocks. From a technical perspective, the S&P 500 remains in bearish territory. It is also facing a myriad of headwinds from earnings to bearish options activity.
Top analysts are now calling for the index to move lower from here. Goldman Sachs (NYSE: GS) recently reduced its year-end price target for the S&P 500 to 2,000 from 2,100. If the prescient financial firm is correct, the index will finish down by nearly 3% for the year.
Taking a short position in the SPDR S&P 500 ETF (NYSE: SPY) is one way to profit from a deeper correction, but it may not offer the best risk/reward if the index stays flat or drifts lower.
Instead, to make the most of the mounting bearishness but also profit if the market trades sideways, I’ve got a unique trade for you today.
Stock Market Risk Growing
The S&P 500 still faces a serious uphill battle. On the chart, there is key technical resistance at the 200-day moving average at 2,060, which is less than 2% above current prices.
Q3 earnings season is upon us, and FactSet forecasts companies in the S&P 500 will post a 5.5% year-over-year decline in EPS. This would result in the first back-to-back quarters of earnings declines, i.e., an earnings recession, since 2009.
Another warning sign is the investor doubt that’s building beneath the surface, as evidenced by the options market. As MarketWatch pointed out, Ryan Detrick, head strategist at Kimble Charting Solutions, said a fear indicator called the CBOE Skew Index hit an all-time high this week.
The Skew Index measures how much traders are willing to pay for out-of-the money put options on the S&P 500 compared with call options. A high Skew Index signals nervousness among traders who are paying up for protection in the form of put options.
In fact, Detrick said demand for puts spiked to levels not seen in more than two decades, meaning traders are betting on a black swan-type market crash right now.
Given all these bearish factors, I think it’s safe to say the path of least resistance for the S&P 500 is lower, at least for the next quarter.
A short position in SPY here could return 7.6% if the ETF returns to its September lows near $187. The trade I’m about to share with you, though, could make you three times as much while reducing your risk. What’s more, you stand to profit whether the market falls as expected or even drifts sideways, increasing your odds of success dramatically.
All the S&P 500 has to do is remain below the key technical resistance level of 2,060 through the third week in November for us to make the maximum potential profit.
Make a Potential 31% on the S&P 500 in 36 Days
While you cannot buy “shares” of the S&P 500 (SPX) itself, you can buy and sell options on the index. SPX is what’s called a “cash index” and is the real-time value of the S&P 500.
The strategy I plan to use is known as a bear put spread, and it involves simultaneously buying one put option and selling another with the same expiration date but a lower strike price. The option premium from the put sold (short put) decreases the cost of buying the long put.
For this trade, I am interested in buying one SPX Nov 2070 Put and selling one SPX Nov 2060 Put for a net debit of $7.50 or less ($750 per pair of contracts).
Note: Be sure to use limit orders when entering and exiting a bear put spread to get the desired prices.
The breakeven for a bear put spread is the strike price of the long put ($2,070) minus the net debit paid ($7.50), or $2,062.50, which is 2% above SPX’s current price.
The maximum possible profit for a bear put spread is the difference between the strike prices ($10) minus the net debit paid to enter the trade ($7.50), or $2.50. This is achieved as long as SPX stays below the strike of the short put ($2,060) through expiration on Nov. 20.
If the index is above $2,060 at the close on Nov. 20, we will experience a loss. However, no matter how high SPX goes, the maximum loss is limited to the amount paid to initiate the trade, or $7.50 in this case.
I like to set my profit target slightly below the maximum profit to automate the trade and allow for an early exit if the index continues to fall. Therefore, when you enter the trade, place a good ’til canceled (GTC) limit order to sell (close) the spread at $9.80. This would result in a profit of $1.80 for a return of 31% in 36 days, or an annualized gain of 311%.
A bear put spread is the perfect strategy to reduce risk while still benefitting from potential weakness in the broader stock market.
Recommended Trade Setup:
— Buy one SPX Nov 2070 Put
— Sell one SPX Nov 2060 Put
— Enter trade for a net debit of $7.50 or less
— Set GTC sell limit order at $9.80 for a potential 31% return in 36 days
Remember to use limit orders (not market orders) for this trade as the bid-ask spreads are wide.
Note: We hope you liked today’s trade from options expert Jared Levy. While it’s not the typical trade we’ve featured on Profitable Trading in the past, it’s an incredibly lucrative strategy that you’ll likely be seeing much more of in the future.
We’ve prepared a short fact sheet about Jared and how he has used options to become a millionaire several times over. It takes no more than a few minutes to read. Click here to access it.