Window Dressing to End the Quarter? What’s Next? An Options Strategy to Hedge Longs or Get Short.

On the last day of February, 2016 the E-mini S&P June Futures Contract closed at 1928.25. Since then it has rallied 6.5%. On the last day of the quarter it’s time to take pause and look at the market’s current position.  The E-mini’s have a Relative Strength Index of approximately 80, which is, in technical terms, somewhat overbought. In addition, the market has benefited from some lovely statements from Fed Chair Yellen which have elevated its spirits.  There has been little news out of China and Crude Oil has held on to most of its recent gains. If one is interested in taking profits, hedging their longs or initiating a short position, what is the best way to do it?

The main question a trader should ask themselves when establishing a short position or potentially hedging a long position is, “what are the objectives of the trade?”  One can always purchase puts or put spreads in the E-mini S&P, or, for hedging purposes, the large S&P contract. This enables the trader to capture downside protection, but of course at a cost. The main thing to consider is whether the objective is to protect themselves from a small, medium or colossal downside move. The current market environment provides opportunities for downside protection with comparatively low costs. The Implied Volatility of E-mini Options has not been this low is at any point this year. That provides an opportunity to purchase Puts or Put Spreads at comparatively good value.

While insurance prices are lower than at any time this year; meeting one’s risk reward requirements is not always easy to satisfy. If one thinks that the market is topping out and that after at the end of the quarter, later today, there will be a significant drop (say the 1900 level or lower) then the purchase of outright puts will provide a reasonably price hedge or short position. The 1950 Puts are trading at about a 16.50% Implied Volatility with a nominal value of about 13.50. A purchase of these Puts would provide protection below approximately the 1635 level. Should the market fall dramatically between now and the May 20th expiration, they will look like very good purchases. If the market flounders, however, despite the low volatility, one still owns a dwindling asset. For those with the doomsday outlook, however, purchasing puts outright at these levels will be an excellent move. Doomsday is the key.

For those who would like to hedge some of their Longs or get Short, the following Options Trading Strategy with excellent value may meet your needs. It is a Short Options Pairs Strategy which involves selling a Call Spread and buying a Put Spread approximately equidistant from the current trading price. The Table below provides the details. The advantage of this strategy is that it is essentially a volatility neutral strategy which, because of the Implied Volatility Skew, enables the trader to generate a credit on a limited risk options strategy which accomplishes the goal of hedging longs or getting short. As one can see it provides a potential profit on the downside, a lesser loss on the upside and provides limited downside protection. If you are having difficulty understanding these concepts, we provide a practical and simple method of assisting you.  At Options Strategy Network we provide Webinar Training in Trading and Risk Management to assist traders in fine tuning their Options Trading technique:  Contact us  to enhance your understanding of these issues. Our Private Webinar Training Sessions, for a fee of $75/hour, will enhance your Options Trading. 
 
OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. THE 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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