As the S&P 500 peaked last week, I issued a bearish alert to my Profit Amplifier subscribers. We are already up more than 50% on the trade I recommended, but I see much more downside to come in the market.
And that could mean big profits for those of you reading this right now.
Many of you may not be aware of it, but we are currently in a recession. It's not a full-blown economic recession (yet), but it is an earnings recession.
At the end of last week, 444 of the S&P's 500 companies had reported Q3 earnings. According to FactSet, the blended results (actual results for companies that have reported plus estimated results for companies that have not reported) showed a 2.2% decline versus Q3 2014. That's even worse than the second quarter, which ended the season with a 2.1% decline in earnings.
If Q3 earnings growth is still negative once everything has been reported -- and it looks like it will be -- it will be the first time we've seen consecutive quarters of earnings declines since 2009. To make matters worse, analysts expect a 3.7% drop in earnings in Q4.
Despite this, the rally off the late-September lows took the S&P 500 back near its pre-correction highs and drove the index's trailing price-to-earnings (P/E) ratio back up to 18.8, just a hair below its four-year high of 18.9.
Remember, the P/E ratio is the most commonly used gauge of value for stocks and indices; they also like to stay close to their long-term averages. For the S&P 500's P/E ratio to fall back in line with normal levels, one of two things needs to happen:
1. Earnings growth jumps
2. Stock prices fall
Since earnings growth has been negative for two consecutive quarters -- with projections for a third -- I believe the latter is the more probable scenario.
In fact, the correction already seems to be under way with the S&P 500 off 3.3% from last week's peak. But as I mentioned, I think stocks have further to fall, especially given the fact that the current economic expansion is so long in the tooth and a December rate hike is a definite possibility.
I'm not looking for a complete meltdown like we saw in late August, but I am forecasting the S&P 500 will fall to at least 2,000, which is 2.3% below the current level.
But rather than trade the S&P 500, I use the SPDR S&P 500 ETF (NYSE: SPY) -- a very liquid ETF that closely tracks the index. Since the fund is one-tenth the price of its index counterpart, the downside target for SPY is roughly $200.
But with the trade I have for you today, all SPY has to do is stay below $212 -- a level it failed to eclipse during its most recent rally -- through mid-December and we will make the maximum profit. This significantly stacks the odds in our favor.
Make A Potential 21% Return In SPY In 36 Days
The strategy I plan to use is known as a bear put spread, and it involves simultaneously buying one put option and selling another with the same expiration date but a lower strike price. The option premium from the put sold (short put) decreases the cost of buying the long put.
For this trade, I am interested in buying one SPY Dec 216 Put and selling one SPY Dec 212 Put for a net debit of $3.30 or less ($330 per pair of contracts).
Note: Be sure to use limit orders when entering and exiting a bear put spread to get the desired prices.
The breakeven for a bear put spread is the strike price of the long put ($216) minus the net debit paid ($3.30), or $212.70, which is 3.8% above SPY's current price.
The maximum possible profit for a bear put spread is the difference between the strike prices ($4) minus the net debit paid to enter the trade ($3.30), or $0.70. This is achieved as long as SPY is below the strike of the short put ($212) at expiration on Dec. 18.
If SPY is above $212.75 at the close on Dec. 18, we will experience a loss. However, no matter how high the stock goes, the maximum loss is limited to the amount paid to initiate the trade, or $3.30 in this case.
When you enter the trade, place a good 'til canceled (GTC) limit order to sell (close) the spread at $4. This would result in a profit of $0.70 for a return of 21% in 36 days, or an annualized gain of 215%.
Recommended Trade Setup:
-- Buy one SPY Dec 216 Put
-- Sell one SPY Dec 212 Put
-- Enter trade for a net debit of $3.30 or less
-- Set GTC sell limit order at $4 for a potential 21% return in 36 days
Note: If you're interested in trading options and have six minutes to spare, check out this training video. In it, a millionaire trading prodigy reveals his two-part strategy that's delivered annualized gains of 220%, 508%, even 2,201% -- and allows you to profit whether stocks go up or down. Watch it here for free.
This article was originally published on ProfitableTrading.com: Profit From The Recession No One Is Talking About