Options Action

The Big Bet That the S&P Will Soon Make an All-Time High

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On Thursday, as the Dow made a new all-time high for the third consecutive day, one options trader made a bet that the will make all-time highs by April expiration.

The trade was the purchase of 50,000 April 160/161 call spreads for a cost of $0.13 each. This is bullish trade that risks $650,000, and it will make $4.35 million if the S&P 500 ETF, SPY, is above $161 at April expiration. SPY is already up 8 percent year-to-date, and this trade bets that it has another 4 percent left to rally over the next five weeks.

So why might the S&P reach an all-time high?

First, we have recently seen a slew of data surprising to the upside. Thursday morning, non-farm payrolls came in at 236,000 versus an expected 171,000. Last week, ISM manufacturing came in at 54.2 versus the 52.8 expected, and Chicago PMI came in at 56.8 versus an expected 55.0.

Second, Federal Reserve Chairman Ben Bernanke, along with Vice Chair Janet Yellen and Fed Bank of New York President Dudley, have been reassuring investors that the Fed will continue to keep rates low for a while. This means that markets can rally on good news, without having to worry that the economic data is so good that the Fed will stop easing.

Finally, the return of the housing market is helping retail investors feel better about their finances, and giving them the courage to spend and even buy stocks.

However, this market will not continue to go straight up, and a 4 percent move higher in the S&P 500 is about a one standard deviation move between now and April.

There are a lot of people out there who are hesitant to buy into this market at all-time highs, but who are happy to buy it on the dips. I expect each dip to be bought for the near term, which means it will be important to have positions on that you will not get shaken out of on downticks.

Call spreads like this can be used to replace profitable stock positions, so you can take risk off the table while continuing to participate in this rally if it continues.

Disclosures: None to report.

Brian Stutland is Managing Member of Stutland Equities and a contributor to CNBC's "Options Action."