Every Sunday night, I put one number on the S&P 500 chart.
It’s the expected move, the range the options market is pricing in for the week, and I grab it at 3:17 p.m. Central on Friday. This week, it’s $153.49.
On Monday, I put on a trade aimed right at the bottom edge of that range, 7,470 on the S&P 500 index, or SPX. It cost me 25 cents. That’s $25 for a one-lot, which doesn’t even get you a decent meal at McDonald’s.
Everybody’s telling me, “You’re out of your freaking mind, man. We ain’t going all the way down there.” Good. I like it when people say that.
Why It’s So Cheap
The trade is a put butterfly. You buy one put, sell two puts at a lower strike and buy one more put below that. It costs little, and it pays the most if the index lands right on that middle strike at expiration.
This one is $20 wide. If the SPX finishes right on 7,470, that $25 can be worth as much as almost $2,000.
You’re never going to make two grand. I’ve made about a thousand bucks on these, and turning $25 into $500 is something we’ve done plenty of times here.
These are cheap this week because of skew, which is how much more traders pay for downside protection than for upside bets. Skew is up around 150 right now, and the higher the skew, the cheaper the put butterfly. When the market was sitting right in the middle on Monday, the same trade on the call side cost 70 or 80 cents.
Do It Consistently
I don’t have a high probability of this trade working. But if you do that trade consistently, there’s a positive expected return at the end of the year. You only need a few of those to pay off all year to make it worthwhile.
Some people love that style of trading. Some people loathe it. Whatever does it for you, pick a management style and stick with it.
Even if you’re going to do something wrong in this life, do it consistently. If you’re going to be a total screwup, be consistent in screwing up, because at least then I can look at your position statement and show you the inconsistencies.
Before The Fed
This week is loaded. The Fed announces its decision on Wednesday, the same day roughly $10 trillion of market cap reports earnings.
So you’re aware, there can be dramatic positioning before the Fed and before those earnings, because traders re-up their hedges, and that can move markets in a big way. You won’t have a clue whether it’s bullish or bearish until it happens.
I’m going live at 2 p.m. ET Wednesday when the decision hits. You’ll see how the big institutions, the options market and retail traders each react in real time, and what the options are pricing for the rest of the year once the dust settles.
→ Save A Seat For Wednesday’s Fed Breakdown
To your success,
Don Kaufman
P.S. I filled another one of these butterflies this morning. It’s a lottery ticket, and I know it. Watch how the Fed treats it live on Wednesday.
