New Trade – $XLP: Did You Try Staples?

by Dan March 26, 2015 3:34 pm • Commentary

Consumer staple stocks have been on our hit list for the last 6 months.  Our most recent trade was a put spread into Proctor & Gamble’s Q4 earnings report in late January (read here).  At the time I felt that given the headwinds from the strong dollar, exposure to weak spots overseas, the fact that investors were attracted to stocks like PG due to their yield despite the lack of growth, and ultimately my belief that an increasingly hawkish Fed would cause investors to flee “defensive” stocks/sectors.

With PG down considerably since January (down 10% on the year), I see little in the near future that should change the sentiment towards the stock and the sector.  Which leads me to the Consumer Staple Select etf (XLP), of which PG makes up 12.5% of the weight, and the four other heaviest weighted stocks (KO, WMT, CVS & PM) making up a total of 40% of the weight.  Of those 5 stocks, only CVS is up on the year.  It is my view that this weakness should continue in this sector and ultimately drag down the whole sector in the weeks/months to come. 

Of those 5 stocks only CVS looks cheap with a very healthy PE/G of about 1, with no sales exposure outside the U.S.   The rest all trade high teens or 20x expected earning growth of low single digits at best.  The XLP has outperformed the S&P 500 so far this year, up about 1% vs the SPX flat on year.  While I am not a fan of trying to pick a top in strong stocks like CVS, I am inclined to press weakness in stocks like KO, PG & WMT.  The safest way to do this is to disperse and define my risk in an etf.

As for the technicals, the stock has held $48 for all of 2015, but not been able to breakout above $50.   I like playing for a break below $48 in the coming weeks and target a move back to the breakout level near $46 in late October:

[caption id="attachment_52267" align="aligncenter" width="600"]XLP 1yr chart from Bloomberg XLP 1yr chart from Bloomberg[/caption]
TRADE: XLP ($48.46) Bought May 48/46 Put Spread for .50

-Buy to open 1 May 48 put for .82

-Sell to open 1 May 46 put at .32

Break-Even on May expiration:

Profits: up to 1.50 between 47.50 and 46, max gain of 1.50 at 46 or lower

Losses: up to .50 between 47.50 and 48, max loss of .50 above 48

Rationale:  risking about 1% of the stock price to possibly make up to 3x what I risked if the etf is down 5% in a little less than 2 months. We will know pretty soon on this trade if the XLP challenges that 48 level. We’ll see how it acts there as far as trade management.