This is a weekly column focusing on ETF options by Scott Nations, a proprietary trader and financial engineer with about 20 years of experience in options.
Stock prices fell the last three days of last week, and closed on Friday with a 3.5 percent loss on the week. For ETF investors who feared they had missed the rally, and lamented not buying in September or October, last week’s decline offered an opportunity to get a bit of a bargain. And those who used a common option strategy could get an even bigger bargain.
The SPDR S&P 500 ETF (SPY | A-99) offers some of the most liquid options in the world, and as such, are a favored contract for investors seeking to create the sort of unique risk/reward profile that are only available to investors who use options.
And why generate those option-based risk/reward profiles? Because they’re often superior to the profile available to investors who eschew options.
SPY has rebounded nicely from August’s messy break precipitated by weakness in China. SPY traded above $211 earlier this month before rolling over—a disappointment for longs, but a relief for investors who had bailed on SPY in August:
Selling SPY Put Options
With prices lower and options more expensive (options generally get more expensive when markets fall), one institutional investor decided Friday was the time to sell put options on SPY.
Selling puts allows the investor to collect the premium paid by the buyer of the options—that premium is the put seller’s to keep—and potentially buy SPY at an effective price below where it’s currently trading.
On Friday, our institutional investor sold a total of 2,162 of the $190 strike puts expiring on Dec. 11 at $0.99. He collected $99 per option, or a total of $214,038. That cash is his to keep, but in exchange for that premium, our put seller agrees to buy a total of 216,200 shares of SPY at $190 per share if the owner of the puts elects to exercise his options, which he’ll do if SPY is below $190 at option expiration.
That means that below $190, his payoff is similar to an investor who owns SPY outright, as you can see: