By Chris Ebert
Note to readers: The weekly updates of the S&P 500 options market are now presented here each Thursday evening. In-depth analysis of the options presented here will continue to be published each Sunday morning.
In the stock market, height is important. But, speed is even more important. If stock prices move too slowly, traders get anxious, even when prices are climbing to new highs. A rally without a little irrational exuberance can be a dangerous thing. Exuberance keeps fingers from hovering over the sell button. Exuberance keeps short sellers on their toes; quite simply, exuberance keeps the Bears away.
The S&P 500 nudged the 2100 level for the first time ever this week. At first glance, that could be considered to be quite an accomplishment; and in some ways it is just that. But such arbitrary milestones – psychologically significant round numbers such as 2100 – generally don’t have any long lasting significance, especially when there is a lack of exuberance.
What is significant is that such an accomplishment for the stock market does not currently include an accompanying accomplishment for many traders in the options market. Option traders, particularly Long Straddle* traders are not profiting from the rally to S&P 2100. Moreover, Long Call* traders are barely eking out a profit these days. Those traders should be rolling in money when the market makes new highs – but they’re not.
About the only option traders who are consistently earning a profit these days are Covered Call* traders, but they earn a profit in all but the most bearish environments. Two things are certain: unless Long Straddle traders begin to share the benefits of this rally, the rally will lack the very exuberance that makes rallies sustainable. And, if Long Call traders begin to lose what little profit that have managed to gather recently, the rally is likely doomed to fail from lack of momentum. A rally to new highs cannot live on Covered Call profits alone.
- Bull Market Stage 1: If the S&P climbs above 2150 rather soon the increase in exuberance would add sustainability to the current rally.
- Bull Market Stage 3: If the S&P falls below the 2100 area in the near future the lack of momentum could doom the current rally to failure.
- Bull Market Stage 2: If the S&P remains in the 2100-2150 range through early March, the lack of enthusiasm could make long-term sustainability for the current rally iffy.
* All profits are calculated at expiration, as a percentage of the underlying SPY share price. SPY is an Exchange Traded Fund (ETF), the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) that closely tracks the performance of the S&P 500 stock index. All options are at-the-money (ATM) when-opened 4 months (112 days) to expiration.
EXAMPLE: If Long Call premium paid is $2 when SPY is trading at $200, the loss is 1% if the option expires worthless.
You are here – Bull Market Stage 2 – the “Digesting Gains” stage.
On the chart above there are 3 categories of option trades: A, B and C. For this week, as of February 19, 2015, this is how the trades are performing on (more…)