I honestly believe that the best way to valuate a market, is through it’s option chains. Option chains represent a lot of analytical work and countless minds working in real time to value the securities they are assigned. That is why I believe currently, the stock market might be too Bullish.
Let me start by asking a simple question, what are the chances the market will end up at or above it’s current level in approximately 1 year? I would argue it’s a coin flip. Yes, historically you have the advantage if you bet bullish, but let’s assume it’s a 50/50 that the DOW index will stay at current levels.
As of today, to buy a 160/170 call spread, you are looking at about $6.90 per contract. That means you are risking $6.90 to gain $3.10. That’s even worse than 2 bet for 1 return. Another way to look at it is if both have a 50% chance, you have the following.
The value of that position:
50% chance of $6.90 loss = -$3.45 value
50% chance of $3.10 gain = +$1.55 value
So each contract is $1.90 in the hole pretty much from the start, bringing you back to the even $5.00 valuation. All that being said, am I about to sell that spread (receive $6.90 and risk $3.10)? The answer is no.
We are simply in too bull of a market. Although some people might ask, “isn’t this the exact time you have to go against the wind?” The market is fully showing massively, insanely bullish, time to bet bear?
My prediction, not yet. I think we are in for three to six weeks of minimal gains or sideways before another correction. I’ll even toss out I think it’s likely for a small correction in Dec/Jan. Now of course anything is possible, but just take a look at the previous large spikes we’ve had and tell me how many ended in an immediate large scale drop?
I’m roughly 40% cash, 40% actual stock (which is unusual for me), and 20% options. Reluctantly bull for the very short-term until we show a real sign of bearish trend.