How to Trade a Mean-Reverting SPY

The SPY has been range-bound this year. So, how do you trade it?

by Adam Warner

Published on Dec 4, 2015 at 9:49 AM

I talk about CBOE Volatility Index (VIX) mean reversion all the time, but there's an even greater mean reversion force going on these days: SPDR S&P 500 ETF (SPY) mean reversion.

With one month to go, the best description we can give 2015 is "One Big Churn." If you don't like the prices one day, have no fear; you'll see a price you like better soon. As SPY failed yet another pop above 210, I took a look at how often we've visited some SPY "fulls" this year. I define that by if the "full" (say 207) was in that day's SPY range. If SPY has a range of 207.10-207.90, that day "saw" just a 207 full; if the range was 207.10 - 209.90, it saw 207, 208 and 209 fulls, et al.

We've had 233 trading days this year. Here's how many days touched fulls from 206-210. "None of the Above" means it never touched any of them (that is, either the high was less than 206 or the low was greater than 210.99.


None of the Above wins. Barely.

Another way to look at it is that the range I considered is about 2.4% of SPY. And on 63.5% of all days, we've at least flashed somewhere within that range. Most days, it was more than just a drive-by. On 73 days (31.3%), it spent the entirety of the day between 206-210.99.

Yada yada yada, we're going absolutely nowhere slowly. This won't, of course, last forever. Maybe this week's market ugliness will gather steam, just like in August.

The problem is, you'll go broke trying to time the end of a trend, so it sets forth some clear strategies. Selling straddles or strangles and hedging conservatively has worked well all year. That has open-ended risk, though, so it's possible one bad hit in the August swoon wiped out several cycles of wins.

That makes iron condors a more desirable strategy, IMHO. It involves selling out-of-the-money (OOTM) call spreads vs. OOTM put spreads. Better yet, sell the call spread into the top end of the range and put spreads at the lower end. It's not always that easy (OK, it's never easy). But in principle, it's worked well this year. And yes, this trend of no-trend will end, but the main advantage of the condor is that the risk is defined as you're always stopped out at the highest and lowest strike. Even if you leg and never sell the opposite side, your spread is stopped out.

Simply just fading moves via futures and index ETFs works well, too. Everyone on Twitter catches every bottom and top, so it must work well. (That's another way of saying it's a good plan in theory -- just be disciplined with risk exposure and stops). Overall churn is awful for VIX ETFs, as we noted the other day. Shorting them works as a way to play for more churn, but the risk is very high, so I wouldn't game it that way.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

A Schaeffer's exclusive!

The Expert's Guide

Access your FREE trading earning announcements before it's too late!



NEW! Explore Schaeffer’s Partners' deals and get connected to top online brokerages with deals tailored exclusively for our readers.  Get answers to your questions regarding transfer fees, commission rates, programs and available discounts related to online trading services.

MORE | MARKETstories

Legendary Stock-Picker Calls Top Stock of 2020
Matt McCall's picks were met with disbelief... Until five soared over 1,000%. Get his latest 2020 pick.
Patent Lawsuit Loss Sends AMRN Stock Spiraling
Amarin just lost a major U.S. patent lawsuit for its heart drug Vascepa
RH Stock Sinks Despite Earnings Beat
J.P. Morgan Securities and Cowen and Company cut their price targets
The Latest Investor's Guide to Precious Metals
Learn how to protect savings and maximize returns by investing in precious metals.