The S&P 500 is about 2 percent from record highs, and one trader is bracing himself for some potentially volatile months to come.
Todd Gordon of Tradinganalysis.com said that a looming Fed rate hike and the "sell in May and go away" adage could bring some sharp moves into the market.
But what troubles Gordon most is the fact that traders appear to be paying for more protection in the form of put options, this despite the fact that the S&P 500 is relatively close to record highs.
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"Volatility is a little bit higher than it should be right now, and I think this is cause for concern," said Gordon on Wednesday's "Trading Nation."
As he sees it, the , which measures how much investors are willing to pay to insure their portfolio against a decline, should be lower. The fact that is it elevated indicates to Gordon that options traders see trouble on the horizon.
"I want to hedge my portfolio," he said.
So, in order to protect his long position in the S&P, Gordon used an options strategy which takes advantage of near-term volatility.
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Specifically, Gordon is selling the May 209-strike put to finance the purchase of the June 209-strike put in the , the SPY. "Basically that means I am going to simply be buying and selling the 209-strike puts in different months."
The trade structure takes advantage of the fact that the nearer-dated put will expire faster than the longer-dated one.
"As volatility increases, the puts that you are long go up in price," said Gordon. "As expiration grows closer for the [shorter-dated options] you will see the May 209-strike puts really start to decline." Essentially, Gordon is looking for the SPY to stay above $209 by May expiration, but fall below it through June expiration.
"This is a good strategy to hedge a long stock portfolio looking for a bump up in volatility," he said.
