A powerful opportunity on E-Mini S&P500 Futures

We have seen enough of the rally in the US Stock Marke Index S&P500 to plot out its next move with a high likelihood. Today, we present you this Trading Brief associated with our alert sent out in the early hours of yesterday. So, how did we arrive at that alert? Read along...

Date: Sep 28, 2024

Market Focus: Index Futures & Options

Time Horizon: 14-day swing

Distribution Time: Pre-Market

Market Overview

The US equity indexes experienced a marginal increase this week, attributed to indications of consistent economic growth and discussions surrounding potential stimulus measures in China. The Dow Jones Industrial Average concluded at 42,313.00, up from 42,063.36 the previous week. Simultaneously, the Nasdaq Composite reached 18,119.59, compared to 17,948.32 the week prior, and the S&P 500 closed at 5,738.17, a rise from 5,702.55. Notably, basic materials, encompassing sectors such as aluminum, building materials, and copper, exhibited strong performance within the US market.

The Chinese Politburo committed to augmenting fiscal spending to attain the annual 5% GDP growth target and to provide support to property markets, following recent monetary easing measures implemented by the People's Bank of China. In the US, the gross domestic product growth remained unaltered from the prior estimate, surpassing expectations. Furthermore, initial jobless claims unexpectedly decreased, and the four-week moving average also exhibited a decline. The August core personal consumption expenditures price index decelerated compared to the previous month, while year-over-year core PCE accelerated for the first time since January 2023. This deceleration was primarily driven by diminishing energy costs and deflation in goods. While the data aligned with the Federal Reserve's recent 50 basis point cut, a marginal increase in the core PCE, coupled with the absence of further improvement in the core CPI and core PPI last month, indicates lingering inflationary risks. Subsequent to the PCE data release, the likelihood of a 50 basis point cut in interest rates in November escalated to 54.8% from 49.3% the previous day, as indicated by the FedWatch Tool. The remaining 45.2% probability was for a 25 basis-point reduction. Now, talking about our position, as you are aware we already sent out an alert for credit spreads. Now, what are spreads? Sophisticated investors and traders may decide to use options on futures to create spread positions. Spreads involve buying and selling different options on the same underlying asset. Spreads can be used to profit from price differences, to limit risk, or to take advantage of expected changes in price volatility. We intend to exploit the surge with a limited risk even as an options seller. Let us look into it.

Technical Analysis

Major Support/Resistance Levels for ES (E-Mini S&P 500):

• Support: 5723, 5708, 5670, 5575

• Resistance: 5900, 6000, 6165

Indicators:

• MACD (Moving Average Convergence Divergence) signals buy

• Bullish divergence on the weekly chart between the price and MACD already manifested a few days ago and will continue forward into the year-end until Christmas.

• Fibonacci extension levels are drawn to point out key levels for exit on the chart below

• Volume Profile - we are talking about the Index Futures in the largest stock market in the U.S. Volume isn't usually a concern as it is a widely traded asset.

• Has strong support on daily & weekly time frames with a breakout of the previous resistance on weekly now acting as a support. This breakout is going to be enormous from a pure price action standpoint.

• No other conflicts on lower and higher time frames.

Chart

Trade Rationale

We are selling options credit spreads that expire in November on the underlying index futures - E-Mini S&P500 for the December series. This trade is also known as Options on Futures and belongs derivative on derivatives class - advanced but highly lucrative.

Derivatives

Asset class: Options

Trade Type: Bull Put Spread

Ticker: ES (choose December Futures)

Sell ES Nov 5900 Put for a credit

Buy ES Nov 5890 Put for a debit

Net credit received to open the spread -$535 /contract

Probability 30%

Return/Risk 1.5

Max Profit ~$600

Margin/max loss $387

Time left 87 days

At the time of this writing, the current price of ES stands at approximately 5804. The Bull Put Spread of -5900p/+5890p (where 'p' denotes put) is predicated on our anticipation of a surge in ES above the 5900 level. This projection is essential for allowing these options to expire without value, thereby enabling us to retain the entire premium collected, which amounts to approximately $535 per contract.

It is noteworthy that we are vending deep in-the-money (ITM) options, signifying that they are already positioned at a loss for us in the event of ES concluding at present levels. However, the credit already received holds intrinsic value (real options price) and some extrinsic value (time value, volatility, etc).

The underlying rationale is straightforward. This deep ITM Bull Put Spread position functions analogously to the Bull Call Spread position, with our primary emphasis being purely directional. While theta decay also contributes, our primary objective is for the index futures to conclude above 5900 to yield profitability by the November expiry.

The risk-to-reward ratio is highly favorable, and it is important to note that this represents an advanced options trading strategy that is not commonly imparted or discussed, except within professional circles. The behavior of a bull call spread mirrors that of purchasing a simple call option, albeit at a reduced cost. The advantage lies in the limited cost incurred when acquiring options with longer expiries, such as those expiring in November. This approach serves to safeguard against theta decay, which works to the detriment of option buyers, resulting in the devaluation of options as the expiry date approaches, potentially rendering them worthless should they conclude at or out-of-the-money.

Strategy

• Catalysts: Upcoming earnings season is a strong catalyst, and historically, the election season has had a significant impact on stock markets, leading to higher rallies right into the election week with increased interest from market participants.

• Risk Factors: None.

• Correlation: We have noticed a strong correlation with other positions in the technology and banking sectors. While this is concerning, we have limited our maximum exposure to 5% of the portfolio for each trade. This means that we can effectively manage any adverse situations that may arise.

• Portfolio Exposure: This trade adds a positive exposure to the overall portfolio beta towards index positions and is a net bullish position for the overall portfolio exposure at the time of writing this brief.

• Maximum Risk: 1-5% of the total portfolio capital. No deviation!

• Hedging Strategy (if applicable): NA.

Summary

We intend to exploit this bullish move and may exit on demand as usual, at which point in time, you will receive an email alert for the trade closed or adjusted. We won't wait until the expiry and as soon as the position approaches from current Deep ITM to ATM (at-the-money), we will close the position in profits as premiums fall drastically with also increased rate of theta in the next few weeks. Watch out for our alerts should you be prepared for an exit.

Closing Notes

This trade is valid only as long as the price doesn't move 3% - typically for a day or two. Don't consider the trade if the stock has moved beyond 170 or don't receive less than $300 for the option spread position, although still a high probability trade, the risk to reward drops, should this happen. We usually don't recommend getting less credit if you are late by a couple of days.