MW This stock-option strategy can give you a winning trade around the presidential election
By Lawrence G. McMillan
A plan to lock in a profit no matter how the S&P 500 reacts after Election Day
The S&P 500 $(SPX.UK)$ SPX continues to trade in a narrow range between 5,760 and 5,870 as it waits for the U.S. presidential election on Nov. 5. A breakout above 5,870 would represent new all-time highs and would be extremely bullish. A close below 5,670 would be bearish and would trigger substantial selling.
Technically, the McMillan volatility band $(MVB.AU)$ buy signal from early August is still in place. Our position has been rolled up several times. The target for this trade is the +4<SIGMA> "modified Bollinger Band," which is at about 5.920.
Equity-only put-call ratios rose a week ago, thereby giving the indication that new sell-signals were sprouting. Yet they haven't risen much this week, which is similar to what happened in mid-September. At that time, the ratios rose slightly but failed to follow through. Soon after they fell back to new relative lows, thus re-establishing their buy signals.
So we are waiting to see if these ratios can rise sharply. If so, that would be the confirmation of new sell signals. Conversely, if the ratios fall below last week's lows, that would mean that they are back on buy signals. Anything in between is not tradeable.
An election-oriented trade
As Election Day approaches, the SPX options expiring just after the election date are quite expensive. Many traders are expecting to see some volatility in the broad U.S. market shortly after the election has taken place. This is an "event," similar to earnings announcements. The most expensive options are the ones expiring just after the election (the event), while the later expirations are less expensive until a normal implied volatility is seen when you look well past November 5.
In theory, one would like to sell these expensive options and hedge them with more reasonably priced options expiring at a later date. In this case, "expensive" refers to options' implied volatility, not to the actual price.
A calendar spread - buy SPY SPY December options and sell SPY November options - would fit this category. The problem is in determining what strike price to use for such a calendar spread. A calendar spread does best if the underlying is right at the strike price of the spread when the near-term option expires. If you were to use the current SPY price as the strike, that would probably not be optimal since the whole idea here is that SPY is going to move in one direction or the other after Election Day.
One approach that can sometimes work is a dual calendar spread: buy a call calendar spread at a strike higher than current prices and buy a put calendar spread at a strike lower than current prices.
For example, the SPY (Nov. 15) at-the-money straddle costs about 19 points. That is roughly what the marketplace is expecting SPY to move (or 190 S&P 500 points). So if SPY were at 578, then you would establish a call calendar spread with a strike of 597 (578 plus 19) and a put calendar spread with a strike of 559 (578 minus 19).
Normally, if the underlying moves quickly to either strike, the overall position will profit. The danger is that 1) the underlying moves well past either strike or 2) the underlying doesn't move at all. In any case, the risk is limited to the debit paid for the calendar spreads.
Ideally, you would wait until Monday, Nov. 4, the day before the election, to establish this spread. But I am going to recommend this specific position outlined here, so that you don't have to guess what strikes to use.
Buy 1 SPY (Dec. 20) 597 call and Sell 1 SPY (Nov. 15) 597 call
Buy 1 SPY (Dec. 20) 559 put and Sell 1 SPY (Nov. 15) 559 put
As of Oct. 30, the call spread cost about 4.40, and the put spread cost about 4.0. So the entire position would be an 8.40 debit. That is the most you could lose, but in reality, the options will have some time value even after a large move, so the practical risk is a little less than that.
After the election, exit the spread if SPY trades exactly at either 597 or trades at 559 at any time. If neither of those prices is touched, then we will provide further guidance in next week's report.
New NYSE highs still outpacing new lows
Market breadth has been poor. The breadth oscillators generated sell signals a week ago, and those signals remain in place.
New highs on the NYSE continue to outpace new lows, although the differential between the two is shrinking. Even so, this indicator's buy signal, which began in mid-August, will remain in place unless new lows outnumber new highs for two consecutive days on the NYSE.
VIX VIX has settled in near 20.0 That is a relatively neutral reading, and as a result, both the "spike peak" buy signal and the trend of VIX sell signal are operative. The buy signal would be stopped out if VIX were to close above 23.14, while the sell signal would be stopped out if VIX were to close below its 200-day moving average $(MA)$, which is currently about 15.60.
The construct of volatility derivatives has also settled into a sort of temporizing mode as we approach the election. It is still the case that SPX options expiring just after the Nov. 5 election are expensive, and that has raised the price of both the November and December VIX futures as well as all the Cboe volatility indices. The most expensive volatility index is the 9-day VIX (VIX9D) XX:VIX9D since the options that comprise its calculation are expiring immediately after the election. So VIX9D is trading higher than all the other Cboe indices.
In a bearish market that would be considered an oversold condition, prior to a buy signal. But in this case, because it is based on this upcoming event, it does not necessarily carry the same bullish potential. Looking out along the term structures, they are quite flat, which is not a meaningful signal.
In summary, we are holding a "core" bullish position as long as SPX continues to close above 5,670. We will add positions based on new signals as they occur.
New recommendation: Cognizant Technology Solutions $(CTSH)$
A put-call ratio sell signal is pending here, and if the CTSH (CTSH) breaks down below support, we want to act on it.
If CTSH closes below 74, then buy 2 CTSH (Dec. 20) 75 puts in line with the market.
If bought, we will hold these puts as long as the put-call ratio remains on a buy signal.
Follow-up action:
All stops are mental closing stops unless otherwise noted.
We are using a standard rolling procedure for our SPY spreads: in any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.
Long 1 expiring SPY (Nov. 1) 560 put: This position is based on the trend of VIX sell signal and would be stopped out if VIX closes below its 200-day MA for two consecutive days. Roll to the SPY (Nov. 22) 560 put.
Long 1 SPY (Nov. 15) 584 call and short 1 SPY (Nov. 15) 604 call: This position is based on the new highs vs. new lows buy signal. It was entered via a bull spread bought at the close of trading on Aug. 15. It was then rolled up twice. It would be stopped out if, on the NYSE, new lows outnumber new highs for two consecutive days.
Long 1 expiring SPY (Nov. 1) 585 call: This was initially a long straddle, intended to capture a large move in either direction. After several rolls, it is now a long call only. Continue to roll the call up every time it becomes eight points in the money. Sell this call now and do not replace it.
Long 6 expiring APA (Nov. 1) 25 calls: This was an MVB buy signal. Sell the calls now and do not replace them, since APA $(APA)$ is quite near the -4<SIGMA> Band.
Long 1 ABNB $(ABNB)$ (Nov. 15) 135 call: Raise the closing stop to $130.
Long 1 SPY (Nov. 15) 584 call and short 1 SPY (Nov. 15) 604 call: This is our "core" bullish position. Stop out of the position if SPX closes below 5,670 for two consecutive days.
Long 2 PLD (Nov. 15) 125 puts: We will continue to hold these puts as long as the put-call ratio remains on a sell signal. Roll down to the PLD $(PLD)$ (Nov. 15) 115 puts now.
Long 4 LX (Nov. 15) 2.5 calls: Stop out on a close below $2.85 by LX $(LX)$ .
Long 1 SPY (Nov. 15) 584 call and short 1 SPY (Nov. 15) 601 call: This position is based on the VIX "spike peak" buy signal of Oct. 14. It would be stopped out if VIX were to close above 23.14. Otherwise, it will be held for 22 trading days.
Long 2 CLX (Nov. 15) 160 puts: This position will remain in place as long as the weighted put-call ratio of CLX $(CLX)$ remains on a sell signal.
Long 4 expiring WBA $(WBA)$ (Oct. 25) 9.5 calls: This is the "alternative" Dogs of the Dow position. Roll to the WBA (Nov. 29) 9.5 calls.
Long 2 APH (Jan. 17) 62.5 calls: We will hold these calls as long as the weighted put-call ratio for APH $(APH)$ remains on a buy signal.
Long 1 BLDR (Nov. 15) 180 put: We rolled down last week, and then BLDR $(BLDR)$ dropped sharply, so roll down to the BLDR (Nov. 15) 170 put. We will hold this put as long as the put-call ratio sell signal remains in effect.
Long 1 SPY (Nov. 15) 578 put and short 1 SPY (Nov. 15) 548 put: This position will remain in place as long as the breadth oscillators are on sell signals.
All stops are mental closing stops unless otherwise noted.
Send questions to: lmcmillan@optionstrategist.com.
Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of "Options as a Strategic Investment". www.optionstrategist.com
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October 31, 2024 08:10 ET (12:10 GMT)
MW This stock-option strategy can give you a -2-
(c)McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.
-Lawrence G. McMillan
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