Posted 6/30/15 14:05pm
The market is at a turning point. The whole year has been very choppy, with trades not willing to make many directional bets. It seems like every bullish headline was followed by a bearish headline and vice versa. Is this the start of a bigger market correction? As of now the S&P 500 is flat on the year, after being up more than 3%.
Worries over a Greek default have caused to market to have a mini-correction, but the question is, will the market enter a full-blown correction? I have been cautious so far this year; most of my trades have been neutral butterfly trades because it has been very hard to pick a direction. The market is at the same point now as where it started the year. I think that the 2nd half will be much more volatile. With worries over a Greek default, a Chinese bubble, and a 2nd half Fed rate hike, I think the catalysts are out there to drive some volatility.
The pundits were right when they said that this would be a stock pickers market. The cyber security space and technology names have been the clear winners. NFLX has practically doubled this year. Other names like AAPL have led the NASDAQ this year, which is outperforming the Dow and the S&P 500. With the S&P 500 sitting at the 200 dma, I think it is time to be extra-cautious or even bearish. I do not see the S&P 500 gaining much steam to the upside until after a correction occurs. The market was stuck the entire year; there was no volume/commitment to the upside. There are no catalysts for the market to go higher. Earnings are decisively weaker, and if it were not for names like AAPL, the market’s fundamental picture would be worse. There are many ways to play a pullback, and ways to profit from one without much risk.
For cautious investors, I think that now is the time to start selling OTM Puts. This strategy offers a way to collect free cash. If you are assigned the stock, you do so at a level which you are comfortable. With the VIX back near 20, premium selling is becoming more attractive. Given that the market is only down 3%, it is hard to get excited yet. By selling OTM Puts, you force yourself to buy the stock at a lower price. By selling the option, you collect a premium. If the stock does not hit the strike price, you collect the full premium.
Let’s look at an example. If one wanted to buy AAPL at $120, but felt uncomfortable buying it at $125, he/she can sell the August $120 Put for $3. There are two ways this trade is profitable:
- First, if AAPL rallies (or stays above 120) you collect the full $3 on August expiration,
- Second, if AAPL falls, instead of being long at $120 you are long at $117 ($120-$3 premium). By selling this put, it makes the risk/reward profile even better.
The same trade can be done in SPY, or any stock. I usually only sell Puts in names that are not extremely volatile or subject to big moves.
I would not make the assumption that the correction in the broader market has started just because of this big sell-off, but given the weak fundamental backdrop, and the increasingly weakening technicals, I think now is time to increase bearish bets, and focus on picking spots on individual stocks. I would use the 200 dma as a pivot point. Above 2055 on the S&P 500 you can remain bullish, below it bearish.
