As expected, the Federal Reserve (Fed) raised rates in it June 15th meeting. Until then, the assumption was that the Fed would incrementally increase rates by 50 basis points (bps) at the next handful of meetings. However, after the hot consumer price index (CPI) number the week prior, the Fed was pushed into a more aggressive 75 bps — the first time they have raised rates 75 bps in one fell swoop since 1994.
We are entering a tsunami of higher inflation and a potential recession all while the Fed is raising rates. Throughout history, as the economy has headed into a recession, the Fed has raced to cut interest rates. We could be in for a pretty ugly scenario moving forward.
This is why I haven’t recommended any extremely bullish strategies. I think we could be rangebound to lower with some bear market rallies for quite some time.
The last scenario is what I want to focus on today: bear market rallies.
Bear market rallies can be fierce. You never know when they will pop up, but it’s usually when you least expect it. Rallisc can happen when fear is at its highest, capitulation is starting, and all hope is lost.
If you want to trade a bounce in this environment, I’d suggest selling a put credit spread and buying a call spread. This can be done costless and it lets you establish a long position with a limited loss on the downside.
July 1 expiration:
Sell SPY 370/362 put spread
Buy SPY 390/400 call spread
If you trade a 1-lot (100 share equivalent), you could make $1k if SPY (S&P 500 ETF) moves up and through the 400 level (+5.5%). This might seem like a lot, but bear market rallies can be aggressive. The potential loss is $800 on the downside if market trades through the 362 put strike.
I am comfortable putting on this type of trade as long as I know the potential loss and manage my risk accordingly. Stay in options at times like these. It gives you a bigger buffer on the downside vs. owning stock. You can also get leverage to the upside with significantly less upfront premium vs. buying shares.
Originally published on InvestorsAlley.com