There are three things to consider when considering whether to be bullish or bearish on SPY.
Earnings stocks continue to climb higher than ever (despite lower expectations). The NASDAQ 100 just closed at its highest level since last August. The S&P 500 (SPY) is on the verge of a breakout above $4200. The VIX closed below 16 for the first time in a year.
It remains to be seen if the stock markets go higher. Momentum can certainly drive prices beyond reasonable levels and to extremes.
To quote Keynes- “Markets can remain irrational longer than investors can remain solvent”. In the short term, markets can and will do almost anything.
Over a slightly longer time horizon, however, there are three things worth considering before you consider getting long stocks at this level. Let’s go back to about a year ago (11 months) when the S&P 500 was at the same price to see what has changed in that time frame.
Implied Volatility
The following two option montages show option prices as of Friday’s close and after the close on June 2, 2022.
On June 2, 2002, the SPY closed at $417.39. On Friday it ended at $415.93, so the same price as Friday, now just a touch lower (0.35%).
On June 16, 2023, the options have 49 days to expiration (DTE). July 15, 2022, options have 43 DTE. So, now some more time (6 days) for 2023 options.
Generally, puts that are closer to the money with longer time to expiration are more expensive. But because the VIX -or implied volatility (IV) – is at a low level, puts are actually much less expensive now ($6.71 versus $11.26 then).
All this due to a large drop in IV from 24.49 to 15.54. The table below puts together a comparison with % of strike (option price /$412 strike price) and downside breakeven ($412 strike price -option price).
So, much lower cost for better security. Like paying a lower insurance premium for a lower deductible with the exact same coverage.
interest rate
The 10-year Treasury yield on June 2, 2022 was 2.913%. It closed at 3.452% on Friday.
At that time the fed funds rate was below 1%, which has now approached 5%.
Undoubtedly, interest rates have risen sharply in the last 11 months.
evaluation
The P/E was 21.51 on June 2, 2022. The P/E stands at 24.14 today—and is close to the richest multiple since December 2021. The last time it was above 24 was on February 2 of this year, which coincided with a significant peak in the S&P 500.
FactSet noted that it is interesting to note that Amazon.com is also the largest contributor to earnings growth for the entire S&P 500 for Q1 and 2023. If this company is excluded, (composite) earnings for the S&P 500 will decline for Q1 2023. An increase from -3.7% to -5.1%, while the projected earnings growth rate for the S&P 500 for CY 2023 will decrease from 1.2% to 0.2%. Either way, earnings are still falling and don’t see much growth in the next few quarters.
Rising interest rates and lower earnings lead to lower valuation multiples — and lower stock prices. Instead, stock markets are returning to new multi-year highs in valuations and all-time highs in prices.
The Fed’s belief that it will cut rates sooner than expected and start improving incomes faster than expected requires a very good leap of faith.
Traders and investors alike may want to hedge this belief a bit. Buying some downside protection with puts that are the cheapest they’ve been in a long time makes a lot of sense – all things considered.
POWR options
What to do next?
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All the best!
Tim Biggum
Editor, POWR Options Newsletter
SPY shares closed up $3.52 (+0.85%) at $415.93 on Friday. Year-to-date, the SPY is up 9.17%, the % gain of the benchmark S&P 500 index over the same period.
About the Author: Tim Bigham
Tim spent 13 years as Chief Options Strategist at Mann Securities in Chicago, 4 years as Lead Options Strategist at Thinkerswim, and 3 years as a Market Maker for First Options in Chicago. He appears regularly on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live.” He is passionate about making the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of POWR options Newsletter Learn more about Tim’s background with links to his most recent articles.
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