The S&P500 hit all-time highs…again.
Now this massive rally in the S&P is going faster and higher than I’d like. At first it was nice to know that my bullish view was finally in play. But as I’ve been reducing my exposure with each leg up – I’m finding it would’ve been better if I had just held on.
This is the kind of trending environment that accelerates so fast – that it leaves everyone behind — except for those who “bought and held” — as Warren Buffett recommends.
You see, when you are Buffett and you are 100% invested in the market — you get to capture 100% of the rally. But if you were to trade around it, you might have caught a few pieces here and there. And oftentimes, some of the big rallies happen overnight, so if you don’t hold overnight positions, you would miss out on those portions.
Yet, the buy and hold strategy would capture the massive moves to their fullest extents.
Simply buying VOO or SPY or dollar-cost averaging in the Vanguard Admiral Share Class S&P 500 Index fund would have fully captured the move (without leverage).
Besides the bullish QQQ put spread we put on in that December 1-2 — which, by the way, was the ONLY window of opportunity to buy in this last month — we also held onto a longer-term SPY calls expiring on December 30 that we initiated back in October before the election.
We bought these way out of the money SPY December 30 ’16 220 calls at $1.93 and sustained the pain down into the election.
We bought way back when ES was trading at 2135 or so — now it’s at 2250.
As you can see from the screenshots to the right, we sold half at 4.07 from 1.93 entry (more than double) – and the other half on Friday at 5.95 (almost a triple).
However, the downside is I kept the position size small (only $800). On average, we sold at around a $5 price — so that represents close to 150% gain on the $800.
From a percentage basis, it’s a solid 150% gain – but really should have put more than just the $800 in this trade – should have done at least twice the size.
Because with the massive rally that’s happened, I wasn’t able to fully capture it, but still, I was able to capitalize on the power of options leverage.
Back in October 13 when I initiated this trade, I did not whether we would rally into the Nov 8/9 election or whether we would sell off into it.
If we rallied into it, then I would be forced to buy at a higher price. At the time, ES was at 2135.
If we dropped, then I would have to sustain pain going down.
Had I done a bull put spread — that loss would have been very big. Now of course, if you were able to sustain the pain and not look at your account size and just hold through for a few months, that bull put spread trade would expire at max profit.
But if you want to avoid your account taking a big draw down for several weeks, you’re going to want to avoid the bull put spread strategy. In a previous podcast, we talked about the risks of put spreads: if you put on the trade and the market immediately drops, your account value will drop way faster than if you held a long call position.
So to avoid this type of risk in this particular type of credit spread, I chose a long call position. That way, even if the markets crash (which it did overnight during the Trump election when the Dow was down 700 points and circuit breakers kicked), the most I could lose is the $800 I put into the long call option – compare to several thousand I would be down if I did a somewhat equivalent put spread. One way to reduce the risk in a put spread is to minimize the distance between the two legs of the put spread – however, doing so will also reduce potential profits.
Still, if I expect an exogenous event that could potentially throw the markets down a significant amount in the immediate term, but I want to capture upside, I would do a long call and take advantage of the built-in risk protector – but opening up the possibility for large gains –assuming I have enough time with the options.
Since back in October, I was not clear on timing, my best bet was to bet on a year-end rally, which is why I chose December 30 calls – that would allow me sufficient time for a rally to take place – and I put a small amount in that would be OK with if it temporarily went to 0. Of course, as the market went up, what I should or could have done was to add to this position.
So while I was able to risk just $800 to make $1,200 using options leverage, my returns could have been enhanced if I were able to time the move better. That way, I wouldn’t have to hold it for so long and if I selected an expiration date that wasn’t so far out, my returns could have been much bigger. So I entered a a few weeks too early, but if I entered just a few days before the election, I would have been able to get bigger percentage returns.
Here’s a video on the power of timing with options.
There is that Fed announcement next week – and if silver loses 16.8 or gold starts to accelerate down, it could get uglier – which is why I had to reduce exposure to the metals complex and consider re-entering at another time.
From the looks of it, this rally has some more room to the upside. My hunch is that we may make it over 2260 by Monday and then consolidate for a few days – perhaps touching towards 2238-ish — and then continue higher by end of the week. We should be staying in this 2240-2290 range in the immediate term.
As mentioned above, December 1 and 2 were the ONLY buying opportunity days in the mid 2180 ES region. That was when we initiated the QQQ put spread. In hindsight, should have added more to SPY in this region — because once we quickly got above 2230 — it starts “feeling” scarier to buy high. Of course, buying high turns out to be the right thing to do in the immediate term.
What is happening now is what I thought would happen in August. Instead, the market went nowhere and frustrated the krap out of me. Now the market is moving way up way faster than I expected – and it appears there won’t be too much of a deep in the next few weeks according to analysis above.
If you want to capture the full extent of any bullish move in the immediate term, a non-leveraged buy and hold strategy could be effective in the next few months. To do so, here are 3 different ways you can get exposure to the S&P500 – in the spirit of Warren Buffett.
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