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Sunday
Dec132015

SPY Dec15 -$213/+$215 Vertical Call Spread: 30% Profit in 41 Days

The 177th trade that SK OptionTrader closed was a vertical call spread on SPY, the ETF that tracks the S&P 500.

Trade: Short SPY Dec15 -$213/+$215 Vertical Call Spread 

Entry: $0.60 

Exit: $0.18

Return: 30.00%

Opened: 23-Oct-15

Closed: 3-Dec-15

Days Open: 41

During October equities rallied exceptionally well, having their best month since 2009. As the month came to a close we believed that this performance was unlikely to be continued over the next six weeks, and that in fact stocks were likely to pull back somewhat after such a rally.

Technical and fundamental factors also indicated that the stellar performance of October was unlikely to be repeated in the near future. Resistance at 2110 had proved tough to break for the S&P, with only minor movements made above the level. We also noted that stocks would likely struggle to make new all-time highs even if economic data was positive, as this would ensure a December rate hike that would likely tighten the bullish effects of loose monetary policy on equities.

Therefore, we took the view that the S&P would not make new all-time highs. This meant that SPY, the ETF that tracks the S&P, would be unlikely to move above $213, which translates to a level of approximately 2130 for the S&P.

To execute this view we sold an SPY Dec15 -$213/+$215 Vertical Call Spread for a net credit of $0.60. This means we sold $213 calls on SPY, but also bought $215 calls simultaneously to avoid unlimited risk. Both sets of calls had December expirations and the difference in their prices meant that we received $0.60 at the beginning of the trade. The $2 spread between the strikes of the calls and the net credit received meant that the maximum gain would be $0.60, with downside limited to $1.40.

If our view that equities were unlikely to make new all-time highs was correct the spread would move from $0.60 to $0.00, with both calls becoming worthless and expiring out of the money. On the other hand if we were wrong, we could have lost $1.40 as the spread could move to $2 with both options in the money. The simple payoff diagram below illustrates this.

Our downside risks were more than twice our potential returns, but given the technical and fundamental factors in play we viewed the probability of the S&P making a new all-time particularly low. This resulted in the trade having positive risk reward dynamics, as our expected losses were far less than our expected gains.

Equities continued to rally through the rest of October, but ran out of steam quickly as they turned lower only four days into November. From here the S&P 500 failed to top the high made in early November and failed to make a new all-time high while we held our position.

We continued to hold the position after equities made a minor selloff towards the middle of the month as this trade held positive theta. This means that time premium eroded as we approached expiration with the S&P below 2130. Therefore we were able to increase the profitability of this trade by holding it past the November lows.

When we exited the trade we banked a 30% gain, which is more than 20 times better than a direct S&P 500 short. The use of the short vertical call spread trade worked well here as it allowed us to directly express our view that equities would not make a new all-time high, but would not necessarily fall, a view that has been proven correct. Consequently, we have banked yet another winning trade for SK OptionTrader subscribers.

SK OptionTrader Trading Record Summary

Number Of Closed Trades: 177

Average Return Per Trade: 28.27%

Average Duration Per Trade: 57.54