Buckle up for long post. Lets get straight into the topics:
Situation: as known to many of you
- Inflation – Peaked? Don't think so. CPI data for month of May is out to be released June 10th, placed before the FED meeting. Get out of your mom's basement and take a look at the soaring gas prices. I think, this is the highest right now for gas prices. Food and other costs does not seem to have gone down either. So we can expect another high inflation number for month of May, released in June (>8%)
- In the past, only way out of SPY slump was easing the interest rates (2019 after 2018 rout, 2020, 2009 etc). Given the inflation is very high and unemployment rate is at a 50 year low, Powell will continue to stay very aggressive on the rate hikes. This is not going to be favorable for stocks. Refer to my post from months ago about effect of rate hikes to stock prices. I will probably need to recalculate the estimates in the earlier post to account for even higher rate hikes — adjust downwards of course.
Strategy:
Put Debit Spreads …. yes that's it. Buying puts simply are more risky. Put debit spreads reduce premium and put a cap to the max profit. For example, when most of the market makers were jacking off to SPY rallying up to 450 back in end of March 2022 (for no reason) I bought SPY 450-440 put debit spread expiring May 20 (after FED meeting) for 2.70$ per contract. Sold those for $8.00 (~200% profit) at early May….
price/expiry/spread/quantity tactics: Buying put debit spreads when SPY is going upwards (for no reason, without positive news) is the time to buy, and HOLD. My contract value went to 2$ at some point, but I held as the reasoning was clear for me. For expiry this is best if you give 4-5 weeks for strategy to play out. As for how big of a spread, I prefer 10, this gives maximum value of $1000 if strategy plays out. I typically try to sell at 80% profit before expiry. Quantity for you? Really depends on how much investments you got in the market and are trying to hedge. Accordingly you can buy quantity of put debit spreads contracts.
Reasoning why it works: Warning, this only works in your favor if you are invested in the market like I am (like invested in SPY, VOO, MSFT, AAPL kind of stocks). For this example lets assume about $15k of investments in large cap, small cap, stocks/funds.
Scenario 1)Market declines: If the market declines 5% (which constantly keeps happening) you are down 750$. Now at the same time, towards expiry the put debit spread has gained in value and closer to maximum profit of 730$ (assuming a 10 point spread like 450-440 SPY, bought at 2.70$ per contract)…. Note the spread gains value towards 1000$ very close to expiry, suggestion is to sell at 80% profit. In this case you will be up .8*730 = $584. Hence this minimizes the overall losses to 750-584$ = 166$.
Scenario 2) Market is up 5%: This rarely happens these days…Even if it does stay up while the put debit spread is expiring, your investments are up 5% by 750$. And assume put debit spread gone to 0$, expiring worthless… in this case you are up by 750-270 = 480$.
Scenario 3) Market stays flat….this is never the case in these times. Even if it does, this is why it is beneficial to buy the spreads atm (at the market) price and not deep OTM. This way if strategy doesn't play out, you can still time the highs and lows in the days putting a limit order.
Why this strategy and not just DCA?
There is a legitimate and serious concern that SPY may go to 300-350$ in the coming months if it hits bear markets. More of not “if” but rather “when” it hits. I do not want to run the risk of losing my investments by such a large percentage, and hence hedging seems to be the best option at the moment. Of course keep cash on the side and invest as it allows. And, given the conditions, buying these spreads and selling at 50-80% profits seems to be the best strategy.
Positions: SPY 400-390 Put debit spread expiring June 21st (why? this is after CPI data and FED meeting, although I feel FED meeting may not cause much issue, as Powell announces everything upfront). Bought at $3.21 per contract, already up 60% as of right now).
There is a good chance of bull run to 420$, could add more if that happens. I wish it happens really and these debit spreads goes to ZERO….. I will be more happy to see my investments go up and not worry about hedging.
Here is my post from 4 months back for interest rate hikes projecting this market downturn with price targets: https://www.reddit.com/r/stocks/comments/sdb1vf/rate_hikes_how_it_affects_analysis/
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