Price action in E-Mini S&P 500 futures this week was interesting to say the least. As the euphoria over the last minute Cyprus bailout deal faded throughout Monday’s session we saw what could have been interpreted as the beginning of a long anticipated correction. Dutch Finance Minister, Jeroen Dijsselbloem, commented on the terms of the Cyprus bailout deal saying that it could become a template for further bailouts in the Eurozone. As these comments fueled fears of contagion, it appeared as if the market would not be able to find a bottom as the ES futures traded to a low of 1539.00. However, into Monday’s close we saw something that we have seen many times this year, buyers on the dip. As Dijsselbloem backed off of his earlier comments the market reversed and closed nearly 10 points off of the lows. We saw similar action on Wednesday as markets sold-off amid uncertainty over the political situation in Italy. The market’s concerns were reflected in an Italian bond auction where yields were pushed to the highest levels seen in the past six months. With uncertainty in Europe growing, could we see the market take a leg higher or is the long anticipated correction upon us?
The biggest thing the bulls have going for them right now is the start of the new quarter next week. With hedge funds massively underperforming the market this quarter we could see some aggressive buying on the start of the new quarter. European concerns aside, the start of earnings season could also serve as the catalyst the market needs to head higher. The one thing that can be said with certainty at this point is that the market is at a key level where the bulls and bears are going to fight for control. The question traders need to ask themselves is how they can most effectively trade their view of the current market, be it long or short.
So what are a few ways a trader can speculate on the S&P 500?
- Buy Individual stocks in the S&P 500. This is a very capital intensive way to take a view on the index. It does, however, offer the opportunity to leg out laggards and add to winners, but this strategy may not track the index perfectly.
- Buy the ETF. The SPDR S&P 500 ETF Trust (SPY). Although this would also be capital intensive, this is an easy position to manage.
- E-mini S&P 500 Futures and Options. This gives a trader the best opportunity to set up a great risk versus reward trade while tracking the performance of the index very well. This is also one of the most liquid futures markets.
If a trader wanted to take a bullish or bearish view on the index they could set up an options trade with a good risk vs. reward ratio. First we have to establish targets. Using the Apr ES 1555 Straddle, we can calculate what the expected upside and downside move is by expiration. Priced around 34 points, this gives us an upside target of 1591 and a downside target of 1523 by April expiration. With the ES futures at 1557 we can now set up trades.
Bullish set up:
Buying the Apr ES 1580-1590 Call Spread for 2.50
Risk: $125 per 1 lot
Reward: $375 per 1 lot
Bearish set up:
Buying the Apr ES 1530-1520 Put Spread for 2.00
Risk: $100 per 1 lot
Reward: $400 per 1 lot
Both of these trades set up for great return on invested capital with limited risk.