Thursday, August 20, 2009

The Sideways Play

The more dogmatic bulls and bears get about the markets, the more I usually begin to pay attention to the possibility of a sideways market. As is often the case, both bulls and bears can make compelling arguments to support their position – and even back them up with a convincing set of facts.

From a technical perspective, while the SPX has bounced more than 50% off of its bottom, there has been very little in the way of pullbacks during the ride up.

So here we sit at SPX 1004, with the major averages just a little below their recent highs and August SPX options set to expire at the open tomorrow. Still, it has been nine sessions since the SPX made its 2009 high of 1018. Finally, while volatility has been declining, the VIX seems to have found a floor in the 24-25 range.

With these factors, I am looking hard at selling some SPX straddles. The charts below show that a single contract SPX September 1000 short straddle (top chart) has a maximum potential profit of $5000, with a profit zone between 950 and 1050. Traders who might be interested in the SPX October 1000 short straddle (bottom chart) have a maximum potential profit of another 50% or so ($7530) and a 50% wider profit zone (from 925-1075) as well.

Short straddles will perform best when markets move sideways and volatility (vega) declines.

Of course, when short trades go wrong, they can get ugly quickly, so anyone looking to enter in a short straddle should expect monitor this trade closely and have all manner of exit strategies mapped out in advance.

Traders who are more risk averse will certainly be interested in checking out butterfly plays instead of straddles.

For additional posts on these subjects, readers are encouraged to check out:

…and the two part SPX short straddle case study:

  1. Is the SPX Going to Stick Close to 900?
  2. SPX Straddle Case Study Update

[graphics: optionsXpress]


Anonymous said...

We are heading into September and are you sure we'll have a sideways market? From my analysis I agree with Ron Insana we may see a 10-15% correction soon.

Eric said...

waiting for the 10-15% correction is killing me.

Anonymous said...

Gary Shilling once said on Yahoo! Tech Ticker (I forgot which video) that this market is a "Chinese water torture". It is. It wears your patience like nothing else. Also notice Doug Kass has turned bearish but then again the market won't make it easy.

Patrick said...

Whoa, I would not be selling volatility at a time like this. Maybe mid-April through June was a good time, but the VIX is just starting to break out, I´m hedging for major trend reversals and whipsaws, correlation is peaking and starting to sputter. You sure you want to pull this trigger?

I´d say now is a good time to go long gamma. Just my personal opinion.

Wayne said...

Looks like Uncle "I saved the world" Ben has different ideas.

Unknown said...

I've never seen so many so-called "professionals" call this market wrong over and over again. Bottom line is it's impossible to guess when the correction will come and the smart money will stay in cash until there's some resolution. I agree with Bill where he said it's far less costly to see a correction in the rear view mirror. At this point it's too risky to stay long and too risky to get in short too soon.

Jeremy Jackson said...

Looks like Uncle "I saved the world" Ben has different ideas.

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