There are a lot of reasons to be negative about the stock market. At the forefront is a hawkish Federal Reserve that appears to be steadfast in its drive to bring down inflation to its 2% target at all costs.
With the S&P 500 in bear-market territory, investors who believe the market will be lower by the end of the year can take advantage using a bear put spread on the SPDR S&P 500 ETF (SPY).
To construct a bear put spread, simultaneously buy a put and sell a put at a lower strike price with the same expiration. For the SPY stock market ETF, investors can consider buying a 370 put while selling a 360 put, both with a Dec. 16 expiration.
To place the trade investors will pay a debit of $4.20. This coincides with a maximum loss of $420 for a block of 100 shares should SPY trade above 370 on expiration. The maximum gain is the width of the strikes minus the debit paid. In this case, a maximum gain of $580 — calculated as (10-4.2) x 100 — will be realized if SPY stock trades below 360 on expiration.
On inception, this trade is equivalent to being short 10 shares of SPY and has negligible exposure to volatility.
Due to the narrow distance between the strikes, it is likely that this trade will either reach a full profit or full loss between expiration. This makes it almost like a binary option, or a coin flip.
Put Spread On SPY Stock Has Defined Risk
The advantage of using a bearish put spread over shorting shares is that there is a defined risk and reward to the trade. Investors can also customize a put spread to express a specific view.
Let’s say an investor thinks there is a good chance the market collapses and the SPY stock trades below 300 by Dec. 16. They could buy five 310/300 bear spreads for around the same debit of $420. If they are wrong they only lose the debit of $420. If they are right, they make over $4,500!
While this trade does have a great risk-to-reward ratio, it is far more unlikely to happen. This explains the higher payoff.
The S&P 500 is down over 23% year to date and is trading below both its 50-day and 200-day moving averages.
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