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SPY - Too far too fast, or a bear trap?
3 min read

SPY - Too far too fast, or a bear trap?

SPY - Too far too fast, or a bear trap?

There has been much speculation about whether we are nearing a top of the bounce from recent lows. Or if all that speculation just means the market will surprise even higher.

Dan Nathan weighs in on RiskReversal this morning on the topic of market valuation:

if you were concerned about the S&P 500’s (SPX) valuation in the lead up to the prior highs in February when the stock market was not the least bit bothered by the gathering storm of the coronavirus globally, the recent hit to corporate earnings, and the subsequent bounce in the stock market has left its forward P/E at nearly the same spot as it was in Feb

And last week, Matt Amberson and the team at ORATS looked for parallels between market volatility now, and 2008:

The 2008 Global Financial Crisis (GFC) has similarities to the current corona market. Back then, implied volatility peaked at 75% at the market bottom. The same happened recently for the corona market. The GFC market rebound topped once when the IV fell to 45%. Corona had a small top at 45% only to rebound quickly to higher highs, a bullish sign. The GFC market topped again at New Years 2009 when IV fell to 35%, but the SPY price slid another 25% to March 9th.

The Set Up

Market volatility, by means of the VIX was above 80 and is now 40, still historically high, but low compared to what the market just saw the past month. What is the options market saying here?

Using OptionsAI technology, the chart reveals that current options aren't pricing in a new high nor a retest of the recent lows, even in the next 6 months!

That's a big difference from a few weeks back and challenges our recency biases. The lows were less than a month ago. The all time highs were just 2 months ago. Certainly either of those could easily happen again in the next month, right? The options market says no, at least for now.

Ways to Play

For those trying itching to short this rally, there are a few ways to go about it. And it largely depends on intentions. Simply fading what could possibly be overbought, or playing for a legitimate retest of the recent lows.

As an example, here's a bearish target on OptionsAI technology, out 2 months, but inline with the bears:

What OptionsAI technology returns is a long put spread to the expected move with a 39% probability of profit. And a short call spread, with 59%. One targets a sharp move lower, to the expected move, the other "sells to the bulls" and is a bet the market does not go higher. The odds a payout are clearly reflected and pulled directly from the options market.

What about trades that target a retest of the lows? A target of $225 returns several put spreads, one that breaks even earlier on the downside but costs more, and the other that is really playing for the big one, a move beyond bearish consensus. You can see what happens to risk/reward vs probability between the two:

In all these cases the trades are defined risk, with easy to understand trade-offs and a simple way to view option alternatives to selling stock or buying a put.

Actionable Insights from the Options Market

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