Buying Puts on the Financial Select Sector SPDR

Buying puts on the financial select sector SPDR multiplied recently as the government entered into consideration of new regulations. Puts to sell outnumbered calls to buy by roughly twenty to one as the SPDR fund price fell nearly two percent, to just above $14 a share. The huge difference has arisen as congress is debating the final terms of new regulations for the financial industry. Poor oversight and banking sector excesses are commonly blamed as major causes of the 2008 market crash. However, many banking insiders are concerned that the upcoming restrictions will damage the financial industry as it tries to get on its feet again. An example of the proposed regulations is that banks may be restricted from trading derivatives. SPDR funds are shares of a family of exchange-traded funds (ETFs) traded in the United States. These funds are managed by State Street Global Advisors. The acronym SPDR comes from the first ETF in the fund, Standard and Poor’s Financial Services Depository Receipts which is designed to track the S&P 500. These funds are set up as unit investment trusts. The financial select sector SPDR a range of financial service firms including JPMorgan Chase, Wells Fargo, and BankAmerica Corp. With new regulations on the way it may be bad times for the financial sector but times of volatility are good times for trading options.

The kinds of options trading that are most profitable will depend upon what the market in the underlying equity is doing. Put call ratios are running around sixteen to one on individual stocks across the financial sector as traders fret over the consequences of tougher regulations on financial sector profitability. Traders buying calls is a sign of faith in the likelihood of stock prices going up. Traders buy puts in the belief that a stock price will go down. If the large majority of traders buying puts are correct then they will be able to sell Financial Select Sector SPDR shares at the strike or contract price at a time when the spot price or market price has dropped substantially. Traders will buy at the spot price and sell at the strike price, pocketing the profit. Traders believe that buying puts on the financial select sector SPDR will lead to profits.

As usual we are not suggesting buying puts on the financial select sector SPDR or buying calls for that matter. This is an exercise in watching market indicators such as the daily put to call ratio and using that information to find advantageous situations for uncovered options trading. When a trader sees a great deal of market volatility but does not know which way the market will go he or she may engage in a long straddle options strategy. In this strategy the trader will buy a call and buy a put on the same equity with the same option expiration date. This strategy costs the trader two premiums but insures that he or she will profit no matter which way the equity price goes. The only way to lose on a long straddle is if the market quiets down and the equity price remains stable. In that case the trader is out the cost of two premiums. If the trader really believes that the equity in question has stabilized then selling both puts and calls can be profitable. This is a short straddle. The profit is two premiums if the equity price does not change but the loss can be substantial in either direction if the price moves dramatically. The point of being aware of the fact that the market is buying puts on the financial select sector SPDR is that knowledge properly used leads to profits in options trading.

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