Posted June 30, 2014 10:10pm
With SPY premiums so low, one could make the argument that it is smartest to buy premium outright. That means, do not sell anything against the long calls or puts. The problem with this is that the market is just not moving. The volatility is so low that the premium is constantly eroding. But, you can take advantage of that. I believe that the market will soon have a mini correction (2-4% fall), and that the put premiums will do quite nicely. But I do not think this will happen until the middle of earnings season, so what I would do is sell weekly puts against them. If the market were to get a pullback, then I would do the same strategy but for the upside. I will outline both the bearish and bullish strategy in this post.
First is the bearish strategy. What I would look at doing is buying a September 190 put, and then every week selling the weekly 190 put. I believe that the SPY will have a pullback to the 190 level. This would represent a 3% pullback and relieve the overbought status of the market, allowing it to continue higher and hit the 200 level. The reason I suggest selling premium are for two reasons. First, it is extra income, and as long as the shorter-term option expires out-of-the-money, it will not take anything away from the profits. Secondly, and more importantly, is that the market has a path of least resistance to the upside. Therefore, I want to finance the purchase of the put to protect myself in case I am wrong. If I can collect 30-50% of the premium that I paid, this strategy would limit my loss to half of what I originally spent and therefore increase my risk/reward. It is more than possible that the market just consolidates over time and has a sideways correction. If this is the case, the premium selling will allow me to not get hurt too badly by the time decay in my long option.
Second is the bullish strategy. I think that if the market were to move higher from here, it would do it in a very slow manner, and the reason for that is because there is very little momentum. There is very little volume and little volatility to have any big moves. Therefore, the way I would play it is to buy an at-the-money put and then every week sell the $1-$2 out-of-the-money call. The reason I am not buying the OTM September call is because I will not be able to sell any premium unless the SPY rallies close to my strike. This is because SPY puts always have a fear premium baked into the puts and therefore always cost more than the calls because puts are usually in more demand and therefore the out-of-the-money strikes still cost a decent amount and can be used in a put calendar strategy.
Overall, I think the market will continue to rally over the course of the next half year, but I think it is important to recognize that there is almost no uncertainty baked into the market now which means that there is a very good probability of having some sort of a pullback really soon.