Yesterday as the Dow made a new` all-time high for the third consecutive day one option trader made a bet that all-time highs will been seen in the S&P 500 by April expiration. The trade was the purchase of 50,000 April 160/161 call spreads for a cost of $0.13. This is bullish trade that risks $650,000 to make a potential $4.35 million if SPY is above 161 at April expiration. SPY is already up 8% year to date, and this trade bets that it has another 4% left to rally over the next 5 weeks.
Why might this be the case? First off, there has been a slew of data surprising to the upside lately. This morning non-farm payrolls came in at 236,000 versus 171,000 expected, and last week ISM Manufacturing came in at 54.2 versus 52.8 expected along with the Chicago PMI which came in at 56.8 versus 55.0 expected. Second, Bernanke, along with Yellen and Dudley, have been reassuring investors that the Fed will continue to keep rates low for a while yet. This means that markets can rally on good news without having to worry that the economic data is so good that the Fed might stop easing. And finally, the return of the housing market is helping retail investors feel better about their finances and giving them the courage to spend and even buy stocks.
However, this market will not continue to go straight up and a 4% move higher in the S&P 500 is about a 1 standard deviation move between now and April. There are a lot of people out there who are hesitant to buy into this market at all-time highs but who are happy to buy it on the dips. I expect each dip to be bought for the near term, which means it will be important to have positions on that you will not get shaken out of on downticks. Call spreads like this can be used to replace stock positions that have profits so that you can take risk off the table while continuing to participate in this rally if it continues.
Why might this be the case? First off, there has been a slew of data surprising to the upside lately. This morning non-farm payrolls came in at 236,000 versus 171,000 expected, and last week ISM Manufacturing came in at 54.2 versus 52.8 expected along with the Chicago PMI which came in at 56.8 versus 55.0 expected. Second, Bernanke, along with Yellen and Dudley, have been reassuring investors that the Fed will continue to keep rates low for a while yet. This means that markets can rally on good news without having to worry that the economic data is so good that the Fed might stop easing. And finally, the return of the housing market is helping retail investors feel better about their finances and giving them the courage to spend and even buy stocks.
However, this market will not continue to go straight up and a 4% move higher in the S&P 500 is about a 1 standard deviation move between now and April. There are a lot of people out there who are hesitant to buy into this market at all-time highs but who are happy to buy it on the dips. I expect each dip to be bought for the near term, which means it will be important to have positions on that you will not get shaken out of on downticks. Call spreads like this can be used to replace stock positions that have profits so that you can take risk off the table while continuing to participate in this rally if it continues.
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