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.

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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