Three things to consider when considering whether to be bullish or bearish on SPY.
Stocks continue to rise on earnings that have so far exceeded expectations (albeit lower expectations). The NASDAQ 100 just closed at its highest level since last August. The S&P 500 (SPY) is on the verge of breaking above $4,200. The VIX just closed below 16 for the first time in over a year.
It remains to be seen whether stock markets will rise even higher. The momentum can certainly push prices beyond reasonable levels and push them to the extreme.
To quote Keynes, “markets can remain irrational longer than investors can remain solvent.” In the short term, markets can and will do just about anything.
However, in the longer term, there are three things to consider before you decide to go long at these levels. Let’s go back about a year (11 months) when the S&P 500 was at the same price to see what has changed in that time.
The two photo montages below show option prices at the close on Friday and the close on June 2, 2022.
Back on June 2, 2002, SPY closed at $417.39. On Friday, it ended at $415.93, so it’s almost the same price as Friday, only slightly lower (0.35%).
Options dated June 16, 2023 have 49 days to expiration (DTE). The July 15, 2022 variants have 43 DTEs. So, a little longer (6 days) for the 2023 options.
Usually, puts that are closer to the money and have a longer time to expiration are more expensive. But since the VIX — or implied volatility (IV) — is at its lowest point, puts are actually much cheaper now ($6.71 now vs. $11.26 then).
All because of the big drop in IV from 24.49 to 15.54. The table below provides a comparison along with strike percentage (option price / $412 strike price) and downside breakeven ($412 strike price – option price).
So much lower cost for much better protection. It’s like paying a lower insurance premium for a smaller deductible with exactly the same coverage.
The 10-year Treasury yield on June 2, 2022 was 2.913%. On Friday, it closed at 3.452%.
Then the federal funds rate was below 1%, and now it is approaching 5%.
Without a doubt, interest rates have risen sharply over the last 11 months.
On June 2, 2022, the P/E was 21.51. Today, the P/E is 24.14, which is close to the richest multiple since December 2021. It was last above 24 on February 2 of this year, coinciding with a significant high in the S&P 500. .
FactSet mentioned that it’s interesting to note that Amazon.com is also the biggest contributor to the earnings growth of the entire S&P 500 for Q1 and 2023. Excluding this company, the (mixed) decline in S&P 500 earnings for 1Q 2023 would widen to -5.1% from -3.7%, while the estimated earnings growth rate for the S&P 500 for 2023 would fall to 0. 2% from 1.2%. In any case, revenues are still declining and do not expect significant growth over the next few quarters.
Higher interest rates and lower earnings should lead to lower valuation multiples and lower share prices. Instead, stock markets are again approaching new multi-year valuation highs and all-time price highs.
The belief that the Fed will start cutting rates earlier than expected and that profits will start to improve faster than expected requires a pretty big leap of faith.
Traders and investors may want to hedge against this belief a little. Buying some down protection with puts, which are the cheapest in a long time, makes a lot of sense all things considered.
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All the best!
POWR Options Newsletter Editor
Shares of SPY closed Friday at $415.93, up $3.52, up 0.85%. Since the beginning of the year, the SPY has gained 9.17% compared to the percentage increase in the underlying S&P 500 over the same period.
About the author: Tim Biggham
Tim spent 13 years as a chief options strategist at Man Securities in Chicago, 4 years as a lead options strategist at ThinkorSwim and 3 years as a market maker at First Options in Chicago. He appears regularly on Bloomberg TV and is a weekly contributor to TD Ameritrade Network’s “Morning Trade Live”. His main passion is to make the complex world of options more understandable and therefore more useful for the everyday trader. Tim – editor Power Options Newsletter. Learn more about Tim’s past, as well as links to his latest articles.
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