Tomorrow the April unemployment number will be released. After last month’s big miss and subsequent sell off we have seen the market come back to the price levels hit before the disappointing number. With the sharp reaction in markets after the last unemployment number, tomorrow’s announcement will be watched closely by traders. The market has been struggling to find direction this week amid a flurry of economic data. Data has been mixed this week — both at home and abroad.
Home prices have seen their biggest gain since 2006, and while this should be a bullish sign for the economy it has many investors concerned over another housing bubble. Soft data out of China has hit the commodity space hard as concerns over global demand grow. The FOMC decision yesterday proved to be in line with expectations. The decision to leave rates unchanged was no surprise to anybody, but some of the language used was interesting. Addressing the possible end of QE the committee stated that levels of stimulus could be lowered or raised depending on economic indicators. Does this mean that another disappointing number will ensure QE will continue on this scale to the end of the year? This thought seems to be what drove the dip buying after last month’s number, and should tomorrow announcement disappoint, then the same sentiment is likely to prevail.
So if a trader wanted to get long the market today but limit their risk in the event of a sell off tomorrow there are a few products they could use.
- SPX options. These options track spot S&P 500 so they wouldn’t be the most effective hedge for a futures trader.
- The ETF. SPY tracks the index very well, but again this is not the most effective hedge on a futures position.
- 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.
E-mini S&P 500 futures and options are the cleanest way to take a speculative view on the market, and by using options a trader can limit their risk during catalyst events like unemployment. Using options also lets traders define their risk and reward potential on the onset of the trade.
Trade:
With the ES at-the-money straddle in June implying a 63.75 point move to the upside or downside we can use this to establish an upside target of 1,645.75. Now that we have a target we can set up an options trade with limited risk and great reward potential.
Buying the ES Jun 1625-1645 Call Spread for 4.50
Risk: $225 per 1 lot
Reward: $775
Breakeven: 1629.5
This trade keeps a trader long no matter what the swings are between now and expiration and sets up with well-defined risk.
About the Author
James Ramelli is the Moderator of the Live Futures Options Trading Room at KeeneOnTheMarket.com where he actively trades futures and options on futures while educating members on strategies, setups and risk management. He has a degree in Finance with a focus in Derivatives Trading and Financial Engineering from The University of Illinois and has been trading for five years. James appears regularly on Bloomberg T.V. and BNN and writes a weekly column for Futures Magazine.