After a seven-week hiatus, the bulls finally made an appearance last week…and they roared back with vigor. The S&P 500 (SPY) managed to climb 6.6% last week alone. This week has been a little different as SPY seems to be consolidating after four straight days of rallying.
After dipping below 20% for a few days last month, the S&P is now only down 12.8% for the year. That being said, implied volatility, as seen through the VIX, continues to stay above normal levels.
So, our first trade out of the gate, hopefully a successful one , will be a bear call spread with at least an 80% probability of success.
As I stated before, IV rank is well above normal. I have no problem selling premium anytime we see an IV rank above 40. So, when the IV rank is sitting at 82.47 there is no doubt options premium is inflated.
IV: 26.56%
IV Rank: 82.47
Expected Move (Range): The expected move (range) for the July 15, 2022 expiration cycle is from 387 to 436.
The Trade
With the S&P 500 (SPY) trading for 410.57 I want to place a short-term bear call spread going out 43 days. My intent is to take off the trade well before the July 15, 2022 expiration date.
Simultaneously:
Sell to Open SPY July 15, 2022 440 call strike
Buy to Open SPY July 15, 2022 445 call strike for a total of $0.70 (As always, the price of spread will vary, please adjust accordingly.)
Delta of spread: 0.05
Probability of Profit: 86.56%
Probability of Touch: 27.47
Total net credit: $0.70
Total risk per spread: $4.30
Max return: 16.3%
Risk Management
Since we know how much we stand to make and lose prior to order entry we can precisely define our position size on every trade we place. Position size is the most important factor when managing risk, so by keeping each trade at a reasonable level (I use 1% to 5% per trade) it allows not only the Law of Large Numbers to work in your favor … it also allows you to sleep well at night.
I tend to set a stop-loss that sits 1 to 2 times my original credit. Since I’m selling the 440/445 bear call spread for roughly $0.70, if my bear call spread reaches $1.40 to $2.10 I will exit the trade. As always, I will keep you updated on the status of the position as it progresses and send any necessary updates as needed.
If you have any questions, please do not hesitate to email me at andy@cabotwealth.com.