Last Thursday was a frustrating day for me. In many Terry's Tips portfolios we were short in-the-money SPY calls and we were negative net delta (i.e., short). On the next day, Friday (also expiration day), there would be a dividend on SPY. This happens only four times each year.
I wanted to be short on Friday because on ex-dividend day, the stock usually falls by the amount of the dividend. Furthermore, SPY had gone up for 8 consecutive days, and I thought a reprieve was surely overdue.
However, I had to buy back all those short in-the-money March calls because there was very little time premium remaining in them, and they would certainly be exercised by their owners so that they could collect the dividend that was payable the next day.
I started thinking about all the other people who were forced into buying back those calls on Thursday (probably making them longer than they were comfortable with), and I became more convinced than ever that SPY would fall on Friday.
I decided to buy a spread that reflected my thinking. SPY was trading about $116.50 on Thursday when I bought 20 SPY March 117 puts and sold 20 March SPY March 116 puts, both of which would expire the very next day. I paid exactly $.50 for the spread, buying the 117 puts for $.83 and selling the 116 puts for $.33. My bet cost me $1000 plus $60 in commissions, or $1060.
The next day, SPY fell as I expected it would, closing at $115.97, and my spread was worth $1.00, exactly double what I had bought it for the previous day. After commissions, I netted $1940, giving me a gain of 83% for the day.
Of course, if SPY had stayed flat, I would have just broken even, and if it had gone up, I could have lost my entire $1060, but I had two good reasons to believe it was headed lower on Friday, and I collected a nice gain on my bet.
This spread is just an example of the kind of thing you can do in the wonderful world of options. Maybe three months from now when SPY will pay another dividend on expiration Friday you might like to do something similar.
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Terry
The eight-day rally came to a halt on Friday for the Dow (DIA). Renewed concerns about Greece's ability to pay its debt left market participants worried about the potential for a potential global economic recovery.
"The economic data so far continues to be friendly, but there are a lot of concerns out there," said Peter Cardillo, chief market economist at the brokerage Avalon Partners Inc. in New York. "The Greek situation is affecting the dollar."
Up until Friday's decline the major indices advanced to the highest level in a year. The majority of the gains for the week were made after it was known that the Fed would hold steadfast on its current economic policies. As a result, three out of the four major indices were able to move higher on the week with the small-cap index, Russell 2000 (IWM), being the exception.
On Tuesday, the FOMC left its benchmark interest rate unchanged giving the economy more opportunities to build a sustainable recovery.
The news that truly sparked the advance and Wall Street's interest was the upbeat view on employment. When the FOMC's last meeting wrapped up Jan. 27, the central bank said, "Deterioration in the labor market is abating." Tuesday's language was far more encouraging, noting that the latest information suggests, "The labor market is stabilizing."
Economic data seemed to have little impact on trading this past week. February PPI was reported slightly lower than economists' anticipated (-0.6% vs. -0.2%) as was CPI (0.0% vs. 0.1%). Moreover, the weekly employment report fell in line with expectations.
In the past year, the CPI has climbed 2.1%. The core rate of the CPI has moved higher 1.3% in the past year, the smallest year-over-year increase in six years.
"The huge underutilization of resources" is putting downward pressure on the inflation rate, wrote Harm Bandholz, an economist for UniCredit Markets.
If current trends continue, the core rate of the CPI could potentially fall below the Federal Reserve's target of 1% to 2% for the first time since 1963, economists said, fueling some worries about deflation.
Technically speaking, the market is slowly moving out of the recent short-term 'very overbought' state to a high 'neutral' to 'overbought' state. This typically means that more declines will occur over the short-term. As for where we are headed over the intermediate-term I would point to the low VIX and the seasonal decennial pattern that are currently in play. I will have more about the indicator and seasonal study in next week's report. Stay tuned!
Andy
Overbought/Oversold as of March 22, 2010
Major Benchmarks