Investoid

I’ve been looking at this trade for the past couple of days, based on my belief that the Federal Reserve will not cut their rates more than 25 basis points next Tuesday. As a result, I expect the markets to be disappointed, or at the very least muted based on the Fed’s decision. Even if the Fed gives the market a half percent cut, this has already been priced into futures prices, and thus I doubt there is much upside regardless.

As a result I am looking to take out a bear call spread on the Dow Jones Industrials ETF, DIA. I want to open a 136/138 bear call spread for a 0.40 cent credit per contract or better. I plan on holding until after the Fed decision, but not until expiration. Based on current option prices, I want to fill this at 55 cents and 15 cents respectively for each option.

If the Dow does start to go up and gets close to or goes through my short option strike, and the market looks like it will continue to climb, then I have a defensive adjustment planned. I’ll be looking to buy back that option at a loss and sell some 140 or higher options, turning the trade into a bull call spread. My thinking is that if the market continues to go up I can partake in the upside a bit and eke out a profit, but if it goes back down I’ll capture the additional funds from the higher options that I short, thus limiting my losses.

Note: I will only be paper trading this strategy, since my current broker forces you to go long first and then short on option spread trades. Since the short contract has a dime spread on it, I don’t want to risk that the market will move down while I’m holding the long position while waiting for the short position to be filled. This is really frustrating and as a result I’ll be moving brokers right away. I am thinking about OptionsXpress, but if anyone has comments on it, Interactive Brokers or others who are good for option trading, please let me know.

I will update this trade next week once we’ve seen what the market does.

Note 2: This is not a recommendation for anyone to perform this trade. Please see my full disclaimer.