The S&P 500 dropped for the first time in eight sessions yesterday, but one big trader thinks any pullback will be modest.
Yesterday's largest option trade appeared in the index-tracking SPDR S&P 500 fund (NYSE ARCA: SPY), led by the sale of 32,000 April 229 puts for $2.67. An equal number of April 219 puts was purchased at the same time for $1.15, allowing them to collect a credit of $1.52.
Puts are contracts to sell a security, which investors typically buy when they’re worried about a drop. (Essentially a hedge.) In this case, he or she took the opposite side of the trade by selling puts. They’re hoping SPY remains above $229 by April expiration, letting them pocket the $1.52 as their maximum profit. Their breakeven is $230.52.
The strategy appears to be targeting the fund’s peak in a peak from late January and early February. Chart watchers often look for such levels to provide support when the broader market turns lower. Should $229 fail to hold, the 219 contracts will protect them against major downside and limit their worst-case loss at $8.48. (That’s the difference between the two strike prices and the $1.52 collected upfront.) SPY closed down 0.09 percent at $234.72.
Essentially, this trader’s so-called vertical spread reflects confidence the market has limited downside risk through early spring. It’s been rallying to record highs since late-2016 amid improving economic data and hopes for regulatory and tax reform. This week brought strong retail sales and better-than-expected regional surveys from the New York and Philadelphia branches of the Federal Reserve. Layoffs, as measured by jobless claims, also remain near multi-decade lows.
The forward calendar is also relatively quiet, with a holiday on Monday and few major events until durable-goods orders and revised gross domestic product the following week.
In summary, the investor is looking past near-term worries and trusting the market’s longer-term uptrend.