Investor Alert
Andrew Giovinazzi

Jan. 2, 2013, 1:33 p.m. EST

Settling into the new year with the S&P

By Andrew Giovinazzi

For all of the hand wringing and noise, Congress decided to raise taxes. The reaction of the market is mostly one of relief, but the fact we did not get a larger rally means stocks wanted to see a bit more meat on the spending side. No doubt the folks on Capitol Hill will haggle away at that again.

I still think this is positive for stocks, in that our government can do something when forced to. Clinton raised taxes in the early ‘90s (with large cuts in government spending with it), and that was not a bad decade for stocks. Right now we need more of the same on the spending side, but the market will have to wait.

For readers of this column, you will notice most of the option trades tried to get around the binomial event of the deficit talks. Save for the Select Sector SPDR-Financial (XLF) time spread, which is doing nicely, there aren't any trades on for the posts I have out.

Right now I think the market will be in a slight hangover after all the stress since the elections. A hangover is a good analogy since it requires time and a lot of sitting around to repair itself. Stock-market volatility is not that different.

What has changed is the short-term perception of movement. That to me means a trade to take advantage of some sideways activity. On balance, the market should have no trouble getting back to around 146 over the next couple of weeks, but it might be in fits and starts. Note that many of the larger names are nowhere near the highs we saw in 2012.

If I think we move higher, but not in a straight line, that is a different type of trade, and it wants to collect time decay, but has relative small risk. That trade is a butterfly . The thing that is always a little tricky is how to set it up.

I think if the market moves, it moves up, and that is the way we want to lean. The idea would be to "break" the upside wing of the butterfly and push it closer to the at the money strike.

For example, as I see the SPDR S&P 500 ETF Trust (PSE:SPY)  trading around 145, the strikes one could pick are Jan 11 Weekly 142/145/146 for around $1.69. This trade pays about $13 of time decay per day on a 10 lot and pays out max if the market does not go anywhere, and we close SPY 145 in by next week.

If the animal spirits keep pumping us higher, this example of the broken wing fly will pay $310 per 10-lot spread, which is not a bad return for nine days. There is also some built-in downside protection to $143.69 as a lower breakeven at expiration. If this type of example is confusing, put it into your trade platform with your broker and take a look at how it performs.

Following the XLF

This diagonal-time spread example (from my last column) in the XLF was down slightly on the fiscal panic, but since it had a capped loss for small dollars, it was never a concern. The 10-lot size it is up $129, and one could look to finance 65% of the June put in just one cycle. If one were to stay at these levels, they could let the XLF Jan 16.5 put expire worthless and sell the XLF Feb 16.5 put or 17 put depending on where things end up, as one potential move.

Link to MarketWatch's Slice.