Last week our premium options trading service, SK OptionTrader closed a trade on SPY, the S&P 500 ETF.
The trade made a profit of 18% in 54 days, but during that period the S&P only gained 2.25%, meaning our trade outperformed the S&P 8 times over.
The trade was essentially a bullish position, so we are very pleased that we were able to outperform the underlying Index by such a large margin. This is after all one of the goals of our service.
However what really gets us going is not banking sizeable profits, but maximising our return relative to risk. The way we structured this trade enabled us to optimize our risk-reward dynamics.
Making 18% when the underlying Index only moves 2.25% is great, but what we really liked about the trade is how it would have performed had a different scenario unfolded. The best part about the trade is that we would have still made 18% had the S&P risen 2.25%, 1%, stayed flat or even lost 1%, 2% or 3%.
So the basic view expressed by the trade was that the S&P would rise, but if it did fall it would not fall more than 3%, which translates to a SPY price of $126. Only if SPY was below $126 upon expiration would we make a loss. We did not just pick $126 out of nowhere; it was the low that SPY made after the Japanese earthquake. We did not think equities would fall below that level as the panic was subsiding and the nuclear situation looked to be under control.
As a side note, we also executed a US treasuries trade as a direct response to the Japanese earthquake, which you can read more about here.
However, now for some more details on why we placed the trade. Firstly, we were getting a strong bullish technical signal from the MACD on SPY. We had been watching this indicator for some time, looking for a bullish crossover under zero. As the chart below shows this signal has worked well in the past. The blue lines mark crossovers below zero and the green are other crossovers, with the gains that SPY made post the MACD cross noted in blue too. The dotted line shows when we placed the trade, this was the exact chart that we were looking at prior to signalling the trade.
Secondly, on the fundamental side, we felt markets had sold off too hard after the tragedy in Japan and we were starting to see signs of strength.
In an update entitled “US Equities Set To Rally” which was sent to subscribers on March 27th 2011 we said:
“Trading in US equities last week produced some positive technical signals in our opinion and therefore we intend to take a long position on the S&P 500 this week. We are not being very aggressive with this trade, looking to sell vertical put spreads on SPY, either in May with strikes of $126/$125 or in April with strikes of $128/$127; we will of course send out full details when we confirm the trade. We will try and sell these spreads at attractive prices, however if that is not possible we will not chase the market and be content to let this opportunity pass if we cannot find suitable trades that fit our risk/reward criteria.
On the fundamental side the stock market continues to rally on good news and often even on not so good news. There is a lot of momentum behind this rally which to us indicates that the S&P should be able to challenge 1350 in the short term [the S&P hit 1350 20 trading days later, and topped out at 1370 three days after that]. Whereas the start of this move was mainly driven by QE2, now the stock market is still managing to rally despite there not being much chance of a QE3. This shows core strength in the market which is backed by the continually strong economic data we are seeing from the US.”
We then sent the trading signal to subscribers during market hours quoting prices that were live in the market saying:
“Following from our recent update, we are taking a long position in US equities and hereby signal to Sell the SPY May 21 ‘11 $126/$125 Vertical Put Spread at $0.18 with 10% of our capital allocated to this trade.
This involves selling the $126 puts (which we sold at $1.61) and buying the $125 puts (which we bought at $1.43), resulting in a net credit of $0.18.”
For more information on how this type of options trade works, please click here.
The aim of this article was to give those who are not subscribers to SK OptionTrader an idea of how we operate and the kind of trading opportunities we strive to identify. We are always looking to optimize the risk-reward dynamics of every trade we place. We did so with this trade and we were able to outperform the S&P eight times over, without taking excessive risk.
Recently we also banked gains of 116% and 108% on GLD call options before the gold correction, but for a full list of all our closed trades you can view our trading record on our website.
Our current focus is on gold and silver, but we have also successfully traded the S&P, Treasuries and other markets.
Our model portfolio is up 338.11% since inception which is an annualized return of 128.07%.
Our average return is 40.41% per trade and the average trade open for 46.27 days.
We have closed 81 closed trades with 78 closed at a profit, success rate of 96.3%
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