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Adviser Tip: Bear Call spread the ASX 200 index (XJO)

Today we are applying a Bear Call spread on ASX 200 index (XJO) which has been consolidating at the top of its range.

Analysis:

The XJO has had a keen run-up followed by a slow push to 6300. These levels are roughly 10-year highs and since reaching them, the XJO has consolidated. It certainly looks like we have run out of steam and a retracement back to trend or key support of 6150 looks appropriate.

The rally has been in spite of a large amount of media focus on negative news, mainly with the U.S – China trade war. In addition, oil has had a considerably large fall recently which dampens some of our key commodity players, Iron Ore is tracking sidewards, and our banks are failing at key resistance and not out of the woods in regards to the royal commission. The only saving grace for our market, therefore, seems to be the AUD/USD which seems to be stalling around these levels.

Locally we also have issues stemming from the housing market and talk of the banks raising interest rates along with Macquarie, and Bendigo banks. Our RBA has said they won’t raise rates this year, which has been applauded by some but criticised by others. It is a fair argument to say we are in the late stages of an economic cycle, with the previous ‘recession’ occurring 10 years ago. Lowering Interest rates is usually a defensive play against economic downturns, but we are sitting at 1.5% which doesn’t provide a lot of wiggle room. With local banks potentially raising their interest rates, it puts further pressure on the RBA to raise the cash rate, which could exacerbate the housing market.

There is plenty more to talk about, but no matter which way you cut it, there seems more out there to be worried about than there is to help push out market higher.

If you believed the XJO’s next move was likely to be bearish but are unsure of timing, then you could consider a Bear Call spread with strikes at or above the key 6300 resistance level.

Doing this would put you in a position where you could actually profit from time decay. So simply being in the trade and watching it consolidate is profitable. You would also be in a position where if the XJO fell you would also profit, and therefore be taking advantage of two out of the three possible movements for our market.

If you saw a quick sharp movement down, then you could consider simply taking profit, but if the XJO did continue sidewards, as long as it remained below your strike levels (presumably set at or above 6300) by expiry then you would make maximum profit. The trade would also expire worthless (which is a good thing!) and you would save yourself exit costs such as brokerage.

The strategy:

There are many different types of options strategy’s used in different market conditions.  The key reasons traders use this style of strategy is that:

  • Benefits from time decay (as time progresses, our trade increases in value).
  • A very popular strategy used in a falling to sideways market.
  • Allows for some upward movement.
  • Can be used by busy people as the risk can be managed from afar.
  • Has the possibility to close out for zero brokerage.