'Jaws' Is Back, This Time on Wall Street

Blog readers may question this penchant for drama this morning, so allow me to offer a little perspective: stocks have rallied this year without a single correction that lasted four days. This sets a new record, according to the team at Bespoke Investment research. Similarly, only four other years since 1900 have seen a higher percentage of up days compared with this year: 1943, 1954, 1955 and 2007.

In other words, this has been a really good year. So much so that investors are questioning how long it can last, according to the American Association of Individual Investors. Bullish sentiment has fallen to 34 percent from 50 percent just one month ago.

Which brings us to our "jaws" chart:

See the wide open jaw about to clamp down on the far right side of the chart (SPDR S&P 500 ETF Trust at the top, Chicago Board Options Exchange SPX Volatility Index on the bottom). Notice how the two came crunching together in 2010 and 2011, and how much further apart they are now. Again, given the length of the current stock rally and the relatively benign level of volatility,this jaw may clamp down once again. That would mean a lower SPY and a higher VIX.

Investors can use options to capture the potential move. Very simply: buy a "call" on the VIX to capture a possible rise, and buy a "put" on the S&P to capture a possible fall. Any gains would depend on how far the SPY might fall and the VIX might rise. Meanwhile, if stocks continue rising and the "jaw" opens wider, the maximum loss is simply the amount paid for the options.

PS: If you bought SPY October-169 puts at $4.30 on July 19, you're already positioned and making money. They're $5.00 today.

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