Labor Day Monday – Market Closed

For the past three weeks the SPY has been trading below the 200dma – the market has been in a correction territory or a technical bearish environment. The longer term buy and hold investor has now given back almost one year of profits which is why that style of trading does not appeal to me.

The SPY will now fight to break that 200dma to the upside and that is something that we saw over the past week where every rally was met with selling. For the past week my expectation was that the market would stage some sort of rally since we were approaching a US banking holiday on Monday.

The tendency for the stock market ahead of a US banking holiday is to rally. However I failed to take into account that we also had a non-farm payroll event on Friday and that turned out to be the fly in the ointment.

Stock Market Drop Trade

About a year ago (around June-July 2014) I had done a study that showed that the stock market has a cyclical tendency. It seems to rally over a 5-6 year window of time and then drops (a lot) only to then stage a comeback that rivals the previous market high prices.

At that time I decided to purchase Call options on the FAZ – it is an index that goes down in price when the financial sector goes up and vice versa. I especially like this index because it is relatively inexpensive and when the market begins to make a price movement to the downside (even a small one) this index can really move in our favor.

I prefer to buy the Call on the FAZ as opposed to a Put on the SPY because the sky becomes the limit on that index using a Call option. While a Put option can only capture the intrinsic value to the downside I like capturing the highest possible price that can be made.

After a series of purchases where I then had to buy back the option and go out further in time (I guess I did not realize the impact that all of the quantitative easing would have on the stock market) it became apparent that the market had become impervious to negative economic and geo-political data – it would not go down.

I guess it was around March or April 2015 where I decided to take action yet again. With all of these purchases and rolling out to longer time premiums I was pretty much at my breakeven price. So I decided to try it one last time.

I decided to purchase the January 2016 13Call on the FAZ. The premium was 2.60. Because the market continued to rally remember that this index goes in the opposite direction and continued to lose value.

It went down to about $0.35 to $0.50 (I stopped looking). I was not now looking to make money – I wanted to get my investment capital back (hopefully well before January 2016). The cycle of the market had indeed been impacted and I could not continue to fight that trend.  I was really unconcerned since I have been busy having success with other shorter-term instruments.

However the opportunity became available when beginning on 18 August 2015 the SPY dropped from a high price of 210.68 to a low price of 182.40 or 13% drop. This caused the FAZ to rally from a low of 10.15 to a high price of 14.80 or 46%.

Back in 2008 a 10% move to the downside on the SPY caused the FAZ to rally 100% however I was okay with 46% move in a few days. My option was sold at 3.10.  While I was pleased to have closed out the trade (actually more than pleased) I realized that being able to make even a slight profit after being negative by more than 80% is a very good outcome indeed!