Using Options Spreads to Trade the S&P

08/06/2010 12:01 am EST


The S&P seems to be developing some good support at this level. Technically, it seems strong, and if one lacks a strong directional bias but is comfortable getting long well below the current levels, a strategy using S&P put options may provide an interesting proposition. Last night's September settlement of 1124.60 is 100 points above the 1020 level, which seems to be pretty good support. If one is comfortable that the market will remain above that point between now and September 16, buying the September 1100/1060 1X2 put spread may be worth considering.

Figure 1
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The strategy provides for the purchase of one September 1100 put (which settled at 21.70) and the sale of two September 1060 puts (which settled at 12.70) for a credit of 3.70. The options strategy makes money with the September S&P futures contract trading above 1016.30 (less slippage and commissions) on the expiration day of September 16. There are many issues to be aware of: 1) The September options are cheaper (based on Implied volatility) than other months; 2) The implied volatility has been falling for a while and will likely increase if the market starts to sell off, which would cause paper losses on your statement; and 3) One should only enter into the transaction if they would feel comfortable getting long the S&P around the 1020 level.

If your market timing is correct, buying a 1X2 put spread can be an excellent speculative position. However, an issue to keep in mind is that we are in the midst of a rally, and if there is a correction, the timing of the trade is suspect. What makes a trade like this interesting is the skew in the S&P options market. The options and futures in the S&P—due to the implied volatility skew—make creating options positions quite interesting. This discussion is more to provoke thought than to spur a transaction. Options provide the opportunity to be creative and find value that isn't always transparent. This trade is right for a certain mindset and thought provoking for all others.

By Fred Oltarsh of Libanman Futures

All strategies involve implied volatility analysis, and vega and delta calculations. In addition, understanding slippage is essential. Please call me to be sure you are using the correct strategy for your needs.

Futures and options trading involve significant risk and are not suitable for every investor. Information is obtained from sources believed to be reliable, but is in no way guaranteed. Past results are not indicative of future results.

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