Entering Down Trends Short After Strong Rallies

Another thing you can do after a strong counter-trend rally in the contract you’re looking to short, is to buy puts or longer-dated puts. The June 1250 puts on the S&P 500 emini are priced at $2,400 and have 91 days until expiration. Rallies can make put options cheaper and by owning puts you are still trading with the overall trend.

If you are wrong, and the trend reverses up, you have a defined loss with the puts that you don’t have with the futures. Plus, with 91 days until expiration, you have time for the down trend to resume, as well as have more information about Japan and the potential for QE3 to evolve.

Another benefit is that you are short over the weekend with the puts, whereas you are not if you are a day trader and go home flat on Fridays. This way, if there is bearish news released on a Saturday or Sunday, you’re already short and have limited loss exposure.

The key is to not over lever your account. With each option costing $2,400, make sure that you don’t put an inordinate amount of your equity into any one position. If you have a smaller account, there’s not much you can do about it, but you don’t have to let the premium go to zero either. You can risk 50% of the premium before you offset it.

You have to define your risk and know that trading futures and options on futures can involve loss. The professional traders know what they are going to lose before they put the trade on. I suggest you do the same and don’t risk what you cannot afford to lose.


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