Trade Update – $XLU Playa

by CC December 17, 2015 3:15 pm • Commentary

Heading into Wednesday’s FOMC rate hike we adjusted our long positioning in the utility sector etf XLU. We rolled a long Jan 43 call into a long Feb 42 call to pick up deltas after the sell-off (we remain short a December 44 call as part of the original call calendar position). We also detailed the February 42 call buy for 1.00 on its own for those with no prior position. Here is our current position and our rationale:

Soft U.S. Treasuries yields in front of the expected rate increase this week suggest to me that that rates aren’t going anywhere (for now), and that investors may revisit high yielding sectors/stocks in the U.S. that don’t have exposure to a strengthening of the dollar given their domestic exposure. Utility stocks fit this bill, as the top 5 holdings in the XLU (etf that tracks the sector) make up nearly 40% of its weight and have an average yield of 4.2%

  • Sell to Close XLU ($41.80) Jan 43 call at .30
  • Buy to Open the Feb 42 call for 1.00
New position: Long the XLU Dec 44/ Feb 42 call calendar for 1.20

The 1.20 cost reflects the 20c that the current position is down. But any moves higher from here and owning the Feb 42 will put us in a much better spot than sitting on the January 43 which is farther out of the money with less time. The December short call will likely expire worthless next week at which point we’ll look to roll the short call out, possibly to a vertical spread. This roll gives us more time and more deltas for a move higher.

Rationale – If the U.S. dollar were to make up some its lost ground of late investors could once again be attracted to a sector like Utilities which has little cyclical pressure, no overseas/dollar exposure, sports a healthy yield, and is 15% from its 52 week highs made earlier in the year, and testing key long term support.

In doing the roll down and out on the long call we increased our delta positioning and give more time for the trade to play out. We did the roll with the XLU at 41.80 and it has indeed bounced the past few days. With XLU now at $43.70 the trade is worth about 1.85. So the roll was good timing.

But now what?  

The Dec 44 call we’re short has just one trading day left until expiration. It’s currently offered at .02. The chart looks great today as XLU has now broken above both the 50 and 200 day converging averages:

[caption id="attachment_59377" align="aligncenter" width="566"]Screen Shot 2015-12-17 at 12.30.48 PM 6 month XLU from LiveVol Pro[/caption]

If it can hold these gains 45 seems like a decent target on the upside. Because the position is essentially a long February in the money call (with gains) at this point we should look to reduce or premium risk. So we’re going to turn the February into a vertical call spread by selling the Feb 45 calls:

-Bought to close the XLU ($43.70) Dec 44 calls for .02
-Sold to open the XLU (43.70) Feb 45 calls at .37
New position: Long the XLU ($43.70) Feb 42/45 call spread for .65 (currently worth 1.50 mark to market)

Our net cost after the initial roll is .85 including the .20 lost on the initial roll from Jan to Feb. If the February purchase is thought of on its own it is also the time to spread, so the roll of the short Dec call doesn’t really effect the timing.

With the new position we’ve reduced some of the premium risk while leaving ourselves with upside on a move to 45 or higher. The position is now +45 deltas so we’ve reduced delta risk in case the stock were to reverse and go down.

ACTION: Sold to open the XLU ($43.70) Feb 45 calls at .35
New position: Long the XLU ($43.70) Feb 42/45 call spread for .65 (currently worth 1.50 mark to market)