Stock investors and financial markets traders have shown clear optimism all year in their efforts to push valuations to new record highs. This has been seen around the world, with the Standard & Poor's 500 and Dow Jones Industrial Average in the U.S., and in the Australian Stock Exchange (ASX) in Australia. Many investors are now wondering how to best position for these trends, and it should be understood that when we are trading at these types of valuations there are aspects that contribute additional risk.
It should also be understood that most of the stock market optimism is well founded. We have seen improving economic statistics both in the U.S. and around the world, and this generally bodes well for corporate earnings and stock prices. Having said that, it is also a good idea for investors to position for the potential downside that we could see if geopolitical turmoil starts to erode confidence in the market at large.
When options trading it is possible to remove many of the risks that are commonly associated with elevated stock markets because your potential losses are predefined. If you want to take a bearish stance on the S&P 500, for example, it is possible to take PUT options at these elevated levels that will show profits if options trading markets fail to rise further. If you are looking at an instrument like theSPDR S&P 500 ETF (SPY, Financial), it is relatively easy to see that we are still trading near the major long-term psychological resistance level at 250.
Stock Market Earnings
Weakening corporate earnings could create difficulties for these markets as we head back into the autumn trading season when trading volumes return to full strength. If you are of the mindset that markets need to correct themselves after the major rallies that have already been posted this year, and you do not want to take a stance that is as aggressive as an outright sell position, it might be wise to consider options positions at current levels.
Similar activity has been seen in the ASX as well. If we take the combined influence that selling pressure in the major global stock benchmarks can have, we can see that it could be very easy for stock markets to start building in bearish momentum as we head into next year. The Australian Stock Exchange is now heading into some very critical long-term resistance levels, and this means that similar options strategies can be taken here in order to play the potential for downside if markets are unable to make a bullish push through here.
Index Trading Strategies
Typically, PUT options can be successful whenever upside momentum in a stock or stock index starts to show signs of reversal. It is more than likely that we will continue to see added selling pressure when we are approaching the next psychological levels upward in the ASX and in the S&P 500, as we see advantages here in using options strategies rather than in using outright sell positions.
Disclosure: The author has no position in any asset mentioned.
