Almost all of my credit spread trading is focused on the S&P 500 via the SPY or S&P 500 futures. Why am I hyperfocused on the SPY? So I can sleep at night (well, try to sleep—I do have a young son and a daughter on the way). The S&P 500 is such a big index that it generally doesn’t move dramatically. In contrast, Netflix recently posted a 31% change in a single week, which is just too much for me to handle. Things really have to go haywire for the S&P 500 to experience such a massive swing—something like the flash crash. Though some traders make tons of money betting on volatility in individual companies, I would rather win small and win often, taking as little risk as possible.
I also know that a lot of traders consider either the technicals or the fundamentals, but I am a strong believer in studying both. If I actively trade 10 individual stocks, therefore, I need to do the homework 10 times over: 10 conference calls to pay attention to, 10 earnings reports to review. Accordingly, the money I make per hour of effort goes way down. With the S&P 500 I only have to keep tabs on the market as a whole. So instead of tracking how well Home Depot beat its earnings expectations, for example, I track how many companies in the S&P 500 beat theirs—and lots of services are available to do the heavy lifting for me.
Da SPY Is Superliquid
By superliquid I mean tons of people trade the SPY every day, and as a result the spread between the bid and the ask price is small. Superliquidity allows a trader to get in and out of the trade very easily, which is a very good thing—there is nothing worse than being unable to make a great trade because there isn’t anyone on the other end of it. Lots of money has been lost trading illiquid products.
Backtesting, Domain Knowledge, and Experience
A friend recently put on one of my credit spread trades. The next morning the SPY opened much lower, leading him to believe he had made a big mistake. With near certainty I reassured this friend that the trade would succeed. I don’t have a crystal ball but I do have enough experience to have a strong sense of how the SPY is going to behave. Countless hours of backtesting underpin my understanding of the probabilities at stake.
Though the trade hasn’t closed yet, at this point a profit looks likely. Having backtested results, domain knowledge, and experience can help you stay calm when times are worrisome. When you trade many different products you simply cannot maintain the confidence that a hyperfocus gives you.
To be clear, I am merely highlighting the benefits of being hyperfocused on one product, not arguing against diversification. In your longer term investing portfolios you want to invest in multiple products.
Related Topics: spy