How to profit from a lag in the market rally

Todd Gordon thinks the market rally is about to cool off, but he’s got a way to play the S&P 500 in case that happens.

“Markets don’t always go up or down,” the TradingAnalysis.com founder said Tuesday on CNBC’s “Trading Nation.” Sometimes “they go sideways, and you can actually use that sideways consolidation to your advantage.”

On a chart of the S&P 500-tracking ETF (SPY), Gordon points out that just over a year ago, the market “settled down into a correction” that lasted about three months after a nice run-up in the early summer. Since the election, SPY has surged 17 percent, and the long run-up has Gordon suspecting that another slowdown to the rally is on the way.

“This sell-off into the election rally in November lasted approximately three months,” said Gordon. “So we might be headed into a period of consolidation, and you can use the options market to your advantage and benefit from that.”

To play such a consolidation, Gordon is using a “butterfly” options put spread. Such a trade involves selling two puts in the middle of the market’s expected range, while buying one higher-strike put and one lower-strike put. The structure is designed to show maximum returns if the underlying stock or ETF is in the middle of the range upon expiration.

In this case, Gordon is selling two of the November monthly 250-strike puts, buying one November monthly 257-strike put, and buying one November monthly 243-strike put for a total cost of $2.50 per share, or $250 per options spread.

The way the trade is set up, Gordon would make a maximum profit of about $450 if the SPY closes at exactly $250 on the Nov. 17 expiration. But since the trade has two break-even points, at $254.50 and at $245.50, Gordon would make money so long as SPY closes within that range.

The maximum loss, on the other hand, is the $250 paid.

Since Gordon won’t make the maximum profit unless SPY closes right at $250, the trader recommends getting out of the trade at a certain point.

“What I recommend you do is as you spend $250, once you start to get to $250 in profit, begin to take that trade off,” he said. “Don’t go for the home run and try and get that $250 pin at expiration.”

As of early Wednesday, SPY was at $250.05, which is just below its all-time high of $250.32.