Ten days ago we placed a somewhat contrarian trade in the utilities etf XLU. It has just sold off on renewed expectations of a Fed rate hike. It tends to outperform the rest of the market when there are assumptions of lower interest rates ahead and it gets hit when the assumption is for higher rates. We thought the sell-off on the stronger than expected jobs number was an overreaction. Here was the trade and rationale at the time:
*Trade: XLU ($42.25) Buy Nov / Jan 43 call calendar for 50 cents
-Sell to open 1 Nov 43 call at 20 cents
-Buy to open 1 Jan 43 call for 70 cents
Break-Even on Nov Expiration:
-Max gain at $43, max risk of 50 cents with a large move above or below the 43 strike.
Rationale: The XLU could be range bound in the well identified support range, but with looming catalysts, and what appears to be growing consensus on what’s going to happen, cotnrarian defined risk trades may soon start to look attractive. The idea here is that the XLU consolidates for the next couple weeks, closes below $43, having the short Nov call expire worthless and then either sell a higher strike call in Dec making a diagonal calendar, or a higher strike call in Jan making a vertical call spread and further reducing the premium at risk.
We’re going to close the November portion of the trade as it expires on tonight’s close and roll it out and up, creating a diagonal calendar:
Update: XLU ($43.40)
- bought to close 1 Nov 43 call for .45
- sold to open 1 Dec 44 call at .45
New Position: Long the Dec 44 / Jan 43 vertical call calendar for .50 (currently worth .70 mark to market)
Rationale – This changes nothing as far as total risk (50c) but with the vertical strikes it can’t lose money if the stock continues higher so therefore it is overall more bullish than the previous same strike calendar. So we’re increasing the delta of the trade (from the original same strike calendar) as the stock goes higher without adding to premium at risk.