Still Trading Without a Safety Net

The rolling over of the S&P 500 index chart is starting to take the shape of an options' time decay; that is theta, which is defined by a slope that accelerates as expiration approaches.

I'm not saying we'll get that cascading waterfall effect, but the fact that put protection remains minimal has me believing/hoping that we could get an acceleration of selling as people find themselves without downside protection. Even with this morning's lower opening, the put/call ratio is just 0.78. While that is above the 20-day moving average of 0.67, it is far from what one expects, given recent market action.

Even as the S&P 500 has declined some 2% in the past three weeks and suffered its largest single-day decline in more than four months last week, the put/call ratio has not risen above 1.0 for nearly three months. That is the longest stretch without a 1.0-plus reading in over 14 months.

Again, I believe this lack of a safety net could lead to an exaggerated selloff as investors find themselves unable or unwilling to buy dips. Next week's quadruple expiration, which comes during a flood of earnings reports, could finally produce the type of volatility worthy of its "witching" moniker.

For my part, I'm once again eyeing some Spyder Trust (SPY - commentary - Cramer's Take) puts, which remain relatively cheap. But having seen similar purchases expire worthless for the past four expiration cycles, I'm looking at using a spread this time to keep the cost down.

For example, the March $139/$135 put spread can be bought for about 70 cents. By using a spread, I can establish a larger position, and then, if a decline does occur, I can use that to sell some nearer-term put premium, which should have inflated premiums. The downside of using a spread, especially one with more than 60 days remaining, is that it is difficult to realize a profit unless the position moves into the money or until you get about three weeks from expiration.

ALL STEVEN SMITH BLOG ENTRIES | POST A COMMENT | READ COMMENTS  

---

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback; click here to send him an email.

To read more of Steve Smith's options ideas take a free trial to TheStreet.com Options Alerts.