Metal Heads – XME

by riskreversal November 8, 2016 12:02 pm • Trade Ideas

Earlier Josh Brown blogged and tweeted about the S&P Metals and Mining (XME) ratio chart to the S&P 500 (SPX), saying:

Ten years of underperformance. A long-term downtrend now being snapped, the year to date gains being consolidated. RSI confirming strength.


Josh makes the case that the constructive price action from near 10 year lows in 2016 has been in spite of poor sentiment in the space:

No one talks about these stocks because they’re boring companies in filthy businesses in a world of subpar global GDP growth and collapsed cross-border trade. This has been the case for a long time as China has sought to reorient its economy away from massive infrastructure projects and the west dabbled in austerity policies.

But now China has turned back on the spigots and developed economies in the west are talking loudly about fiscal stimulus instead of relying on their respective central banks to put themselves over the hump. In the meanwhile, mining and grinding capacity has shrunk around the world as both projects and equipment have been neglected.

There is little arguement about the potential for global fiscal stimulus to reflate this group, and to my eye, we see what Josh sees, the recent consolidation, 130% above the Jan lows, above the long term downtrend:

XME since 2009 from Bloomberg
XME since 2009 from Bloomberg

As our friend, chartist extraordinaire Carter Worth of Cornerstone Macro Research likes to say, “draw the lines anyway you like”, but drawn another way, $30ish appears to be considerable technical resistance at $30, with support near $20:

XME since 2009 from Bloomberg
XME since 2009 from Bloomberg

Taking a quick look at the one year, there appears to be decent near term support in and around $25, the July breakout level, and as stated above, $30, very near the uptrend from the Jan lows appears to be decent upside target:

from Bloomberg
from Bloomberg

Now that a lot of technical mumbo-jumbo, it appears that the long term technical picture has improved from an all out crash, while near term the etf remains range bound with near term resistance 10% higher and support down about 20%.

Taking a quick look at options prices, 30 day at the money implied volatility (blue below, the price of options) has come down considerably from the 2016 highs above 50%, now about 35%, which is fairly rich for a sector etf that lacks idiosyncratic risk, and well above 30 day realized volatility (white line below, how much the underlying has moved over the last month) which is very near 52 week lows. This suggests that despite the etf’s recent consolidation and relative calm of late, options prices trade at a considerable premium to realized, suggesting options prices are expensive:

from Bloomberg

So What’s the Trade?  

If you are inclined to play for a breakout, but think that near term, between now and year end $30 should serve as near term resistance, further consolidating recent gains, then it makes sense to finance owning longer dated out of the money calls by selling shorter dated ones. Therefore we would lean towards selling $30 strike calls in Dec to partially finance a breakout above in 2017:

XME ($26.85) Buy the Dec/March 30 call calendar for .73
  • Sell 1 Dec 30 call at .22
  • Buy 1 March 30 call for .95

Rationale – The call calendar assumes no breakout above 30 this year, but one in the new year. The ideal situation is the etf ending up near 30 by Dec expiration, at which point the short Dec calls can be closed and rolled out to extend the calendar or to establish a vertical in March.