Play the Bounce? Sell a Put Spread

January has been quite the mixed month so far with the market showing some real weakness this morning. For those inclined to be a "buy the dips" person I have a possible strategy for you. Oh, and by the way, I never buy strength and I never sell weakness. When the market is lower I'm looking at the long side and when the market is higher I am looking at the short side. There are plenty of trend or momentum players who consider that foolish, "the trend is your friend" and all that, but I am by my very nature a contrarian.

As I have also stated in the past, I don't like buying or selling options outright but much prefer trading in a spread. Yes, it reduces your upside potential, but it also greatly reduces your risk.

A simple way to play an anticipated upside move is to buy a vertical call spread. That is buying a lower strike call and selling a higher strike call above it. Well, you can also sell the put spread. That is selling a higher strike put and buying a lower strike put underneath. Both spreads are bullish and both have the exact same profit less potential. The difference being that one spread takes money out of your account (a debit spread) and the other puts money in your account (a credit spread). as a general rule, all things being equal, I prefer credit spreads to debit spreads.

By way of illustration, looking at the S&P 500 (SPY) we see that it's trading down right now (9:47 CST)  down about 1% at 182.65. You can buy the February 185-190 call spread at one. This means that you risk one to make four. Well, you can instead sell the 190-185 put spread at 4. This has the exact same profit/loss potential. But instead of spending $1 you take in $4.

So, feeling bullish, want to play a bounce? Sell the put spread instead of buying the call spread.


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