$XLK Tech Wreck?

by Dan April 26, 2016 1:34 pm • Commentary• Trade Ideas

On Friday afternoon I previewed a bearish trade in shares of the Technology Select etf, the XLK (below), and discussed on Friday’s Options Action on CNBC:

I think I was pretty clear that I wanted to try wait for a bounce, rather than press Friday’s lows.  Well here we are hours till AAPL’s earnings, and the the S&P 500 (SPX) is at the same level it was on Friday’s close, while the Nasdaq Composite is a tad lower, as GOOGL & MSFT hover very near Friday’s close, and AAPL is trading at one month lows, down about 6.5% in the last couple weeks.

SO tonight AAPL reports their fiscal Q2 results (read my preview from earlier here), and Facebook (FB) tomorrow night, nearly 25% of the weight of the XLK. If these two stocks merely don’t go up, it will suggest to me that technology stocks could be in for a long summer. If AAPL goes up, it will because expectations heading into the print are so low, and the stock is oversold near term, but I suspect it will be met with resistance at the recent highs. As for FB, I’d be a fool not to consider the potential for a sharp rally (remembering the stock back in late January rallied 15% post earnings on a beat), but at this stage of the game, it would take a massive beat and raise in my opinion for the stock to make a new high in the near term.

So we are now going to get in there, in an attempt to play for a follow through on the very recent weakness in the sector over the Summer:

*Trade Idea: XLK ($43.35) Buy Sept 43/ 39 Put Spread for $1.10
  • Buy to open 1 Sept 43 put for 1.85
  • Sell to open 1 Sept 39 put at 75 cents

Break-Even on Sept Expiration:

Profits: between 41.90 and 39 of up to 2.90, break-even at 41.90, down 3.5% with max gain of 2.90 below 39, or down 8%

Losses: up to 1.10 between 41.90 and 43 with max loss of 1.10 above 43, or 2.3% of the underlying stock price.

Rationale – Implied volatility is extremely low and this trade’s breakeven of 41.90 seems realistic if what we saw was indeed a rollover from a failed breakout to new highs.




High Technical Assistance – $XLK
2:57 pm EDT – April 22, 2016 By Dan

Earlier today I offered some thoughts on Q1 earnings season (read here), but the quick take-away as we finish the second full week of results is that stocks that had low expectations and had not outperformed the broad market from the February lows have done ok (bank stocks), and the opposite for those where the stocks had come within striking distance of their prior highs (GOOGL, MSFT, KO, V & VZ to name a few).  The fairly dramatic weakness in GOOGL and MSFT (down 6% and 7% respectively) is notable when you consider that the two stocks combined have shed $60 billion in market cap today.

Trading single stocks into events like earnings is a fairly difficult way to make consistent money in the markets, even using options to define your risk. As regular readers know, you need to get a lot of things right to just break-even, first and foremost direction, magnitude of the move and timing.  We are huge advocates of overlying options strategies to existing investment holdings into earnings events as they can often be used to add yield, protect gains or add leverage.

Just as was the case last night, nearly $1 trillion in market cap in two stocks report Tuesday and Wednesday:

Apple (AAPL) reports Tuesday night after the close, the options market is implying about a 4.5% one day move, vs the 4 qtr average one day move of about 4%, but in line with the 10 year average. Put another way, the options market is suggesting that share of AAPL could be $28 billion higher or lower the day after results.

Facebook (FB) reports Wednesday night after the close, the options market is implying about a 7.5% one day move (about $24 billion in market cap in either direction), which is rich to its 4 qtr average of about 6.25%, but nearly half of the stock’s 15.5% one day gains following their blowout Q4 results in late January.

I want to look at the XLK, the Technology Select etf, where the top 10 holdings make up about 65% of the etf’s weight.  Of these 10, only AAPL, FB, T & CSCO have yet to report, with all but CSCO reporting next week:

From Bloomberg

From Bloomberg

If AAPL and FB were to disappoint I suspect large cap tech could spend the rest of the Spring retracing a bit of its recent move from the February lows.

A look at the one year chart of the XLK shows the etf’s recent rejection at the prior highs from late last year, with a clear target to its Jan/Feb double bottom back at $38:

XLK 1yr chart from Bloomberg

XLK 1yr chart from Bloomberg

Short dated options prices in the XLK have just come off of the 2016 lows, with 30 day at the money implied volatility (blue) at 15%, below the 1 year average of about 18%.  What is striking is that until very recently, and off the Feb lows, mega cap tech stocks were considered to be safe holdings, as 30 day at the money realized volatility (how much the stock was moving, white below) was at the lowest levels of the last year:

From Bloomberg

From Bloomberg

If AAPL, FB and T were to all disappoint next week, the way MSFT, GOOGL and VZ did this week, the XLK would very likely re-test its 200 day moving average near $42, causing a pick up in realized volatility, making current options prices even with today’s decline prove cheap.

So whats the trade?  

First things first I think if this market has taught us who like to short things anything, is that you don’t press shorts on a down day. With AAPL’s results not until Tuesday night and FB till Wednesday, the trade I am going to detail I hope to trade on a bounce in the XLK, and slap on just prior to AAPL’s results.

Trade Idea: XLK ($43.50) Buy Sept 43/ 39 Put Spread for $1
  • Buy to open 1 Sept 43 put for 1.75
  • Sell to open 1 Sept 39 put at 75 cents

Break-Even on Sept Expiration:

Profits: between 42 and 39 of up to 3, break-even at 42, down 3.5% with max gain of 3 below 39, or down 8%

Losses: up to 1 between 42 and 43 with max loss of 1 above 43, or 2.3% of the underlying stock price.

Rationale: This trade targets a fairly reasonable pullback in the sector after some notable failures at all time highs. By choosing Sept expiration we are allowing ourselves enough time for a correction to play out and therefore doesn’t just specifically target next weeks earnings in AAPL and FB, but will also incorporate Q2 results due in July. But since the index is down today on GOOGL and MSFT and other stocks down in sympathy that have yet to report I want to give it a chance to bounce a little into AAPL and FB earnings. So I’ll be looking to put this on at a slightly higher level on Monday or Tuesday.