It’s easy to generate positive returns when investing in bullish markets, but quite difficult to generate positive returns when attempting bullish investing in short-term bearish markets. However, it is possible to generate positive returns when using bullish investments in short-term bearish markets. And, an actual profitable example will be given below explaining the concept.
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Why Invest Bullish in Bearish Market?
At this point, an investor might ask, “why would you want to do bullish investments in a bearish market?” Two things, first the market can change very quickly from bullish to bearish, so a bullish position entered in an initially bullish market could end up in a bearish market and second, the general trend of the market is bullish, so in the long run bullish investments will fair more favorably than bearish investments.
Bull-Put Credit Spread
The vehicle used for returning a positive return in short-term bullish markets is the bull-put credit spread. The bull-put credit spread is entered for a net credit by selling a first put option and purchasing a second put option further out-of-the-money. The goal of the bull-put credit spread is for the options to expire worthless and retain the initial net credit as profit. The nice thing about spread trading, is you can be close and still be successful. For spread trading, the old adage “close only counts in horseshoes and hand grenades”, could be rewritten “close only counts in horse shoes, hand grenades and spread trading”, as a spread can be profitable, even though the stock or the market moves against the position.
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Down Market Wipes Out All Past Spread Trading Profits
Investors who have attempted spread trading often say, “down markets wipe out all of my past spread trading profits.” For unmanaged spread trades, this is often the case, but for managed spread trades, the success rate increases significantly. Actually, given enough time and persistence, a spread trade with a current loss should almost always be recoverable, but recovering spread trades experiencing a loss is for another article at a later date.
As an illustration for the concept of managed spread trades, an actual profitable example for the PowerOptionsApplied Optium TradeFolioTM will be examined.
Actual Bull-Put Credit Spread Example
On 5/15/2012, a bull-put credit spread for the S&P500 index (SPX) was entered for the PowerOptionsApplied Optium TradeFolio with a potential return of 6.8% (78% annualized). The specific put option sold was the 2012 SPX Jun 1230 at $5.55 and the put option purchased was the 2012 SPX Jun 1205 at $3.95. The bull-put credit spread was entered for a net credit of $1.60 and was selected based upon option pricing located midway between the bid/ask for the options and was found using PowerOptions Mid-Point Spread Chain tool. The bid/ask spread for index options, such as the SPX, is typically very large, so an investor can significantly increase returns by using midpoint pricing (or better). In generally, spread investors should not use market orders, but instead should use net credit/debit orders and should also use midpoint (or better) pricing.
At June options expiration, if the price of the SPX was greater than the $1230 strike price of the short put option, then the the full profit of 6.8% (78% annualized) would be realized for the position.
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The SPX bull-put credit spread was entered on a day when the market was down and had been down on the two prior days, as it is generally a good idea to enter a bullish index spread when the market is down and has been down for a couple of days. Entering a bullish position on a down day takes advantage of the market returning to its short-term mean following a few down days.
A chart for the SPX on the day the SPX bull-put credit spread was entered is shown below:
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Management Point
A management point of $1280 was set for the position. If the price of the SPX index dropped below $1280, then the position was to be managed for an exit or a roll. The management point is set for several percentage points out-of-the-money away from the $1230 strike price for the short put option, as attempting to manage bull-put credit spreads closer to at-the-money can be problematic. A chart illustrating the management point is shown below:
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On 6/1/2012, the SPX transgressed the $1280 management point and closed at $1278.04 as shown below:
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Transgression of Management Point
On the day of the transgression, the conditions for exiting and rolling were analyzed. The 2012 SPX Jun 1230 Put option could be exited (purchased) for $8.35 and the 2012 SPX Jun 1205 Put option could be exited (sold) for $4.95 which represented a net debit of -$3.40 which would have resulted in a total net debit of -$1.80 (net debit of -$3.40 subtracted from $1.60 initial net credit) or a loss of –7.7%. It is generally not a good idea to exit a spread trade for a loss, so the position was analyzed for a roll.
Rolling to New Position
Using PowerOptions Mid-Point Spread Chain tool, it was determined the position could be rolled to the 2012 SPX JUL 1080/1205 bull-put credit for a net credit of $1.00, as the 2012 SPX 1205 put option could be sold for $21.30 and the 2012 SPX 1080 put option could be purchased for $16.90, representing a net credit of $4.40 for the new position. The net credit for substituting the new position for the old position, or rolling, can be calculated as the net debit for the old position subtracted from the net credit for the new position or $4.40-$3.40. The total potential return, including the new net credit of $1.00, was 11.1% (60.5% annualized). The total potential return has been increased over the initial positions’ 6.8%, however, the annualized return has been decreased from the initial positions’ 78%. The decrease in the annualized return is O.K., as it allows us to increase our total potential return and move a position away from potential trouble.
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The roll to the new position was executed using a multi-leg trade for a net credit of $1.00 via the following order:
Day Order – Sell to Close $SPX 2012 Jun 1205 Put
Day Order – Buy To Close $SPX 2012 Jun 1230 Put
Day Order – Buy to Open $SPX 2012 Jul 1180 Put
Day Order – Sell To Open $SPX 2012 Jul 1205 Put
Net credit $1.00
New Management Point
A new management point for the new trade was set at $1247. If the price of the SPX dropped below $1247, then the position was to be managed for an exit or a roll. The location for the second management point is shown in the graph above.
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Profit!!!
At July options expiration on July 20, 2012, the price of the SPX settled for $1370.28 which was above the $1205 strike price of the short put option, so the position was fully profitable and returned 11.1% (60.5% annualized). A chart illustrating the location of the $1205 strike price for the second position is shown below:
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You can take advantage of PowerOptionsApplied’s expertise in management of spread trades, as our positions are autotraded by select brokers. The brokers can automatically place the trades for your account per our trade recommendations. So sign up today, try it for 30 days, and within 30 days if you determine the service is not for you, then we’ll happily refund your initial subscription fee.
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