XLK – Tech Is Out, What’s it All About?

by riskreversal December 1, 2016 12:36 pm • Trade Ideas

I sincerely have no idea whether the rotation out of growth stocks, primarily Tech, and “yield-ers”… Consumer Staples, Telco and Utilities, into Banks, Industrials, Materials and Oil stocks is healthy with the broad market at all time highs.

I get why investors have a new found optimism about bank stocks given the rise in interest rates and the prospect for a more lenient regulatory environment. I get why oil stocks caught a bid with the news of the production cut from OPEC, despite the recent rise in the dollar. I get why Industrial & Materials stocks have ripped on the promise of a massive infrastructure plan. And I get why Consumer Staples stocks have gotten walloped with the dollar rise given their overseas exposure.

But have we gone to far too fast overall? I have no idea. But the give back in Biotech/Pharma, and the out-of-the-gate weakness in Tech is troubling.  Biotech/Pharma that initially saw a sharp post election pop has since given back much of their gains as a group and seems poised to fill in the gap. And if the S&P 500 (SPX) is going to sustain recent gains and establish a new range above the prior highs, it is unlikely to do so without the Technology sector, which is the largest weighted sector in the index. And more specifically it can’t without the $2 trillion in market cap of Apple (AAPL), Alphabet (GOOGL) Amazon (AMZN), Facebook (FB) & Microsoft (MSFT).

Earlier we had some thoughts on the so called FANG stocks (ex Netflix, MorningWord 12/1/16: FANGs Out). To our eye they probably have a little more room to the downside, but should find some near term support in not too long.  Which brings me to the XLK, the Technology Select etf. In early September, when the etf was trading very near current levels we detailed a bearish trade looking out to Jan expiration, watch here from CNBC’s Options Action:

Why the focus on XLK? From Sept 9th:

  1. the largest component, Apple (AAPL) makes up 13% of the etf’s weight, and it is my opinion the stock is not going to trade above the recent highs of $110 for the balance of the year.
  2. without the help of AAPL (down 1.5% ytd), a particular focus will be placed on what I call defensive no growth tech stocks like Microsoft (MSFT), Intel (INTC), Cisco (CSCO), Oracle (ORCL) and IBM which make up almost 30% of the weight. All would be very vulnerable in a cyclical downturn.
  3. then you have AT&T (T) and Verizon (VZ) that make up 10% of the weight, up 16% and 12.5% respectively, largely a result of investors reach for yield (4.8% and 4.44% dividend yields respectively).  If rising rate assumptions prove to be correct, these two stocks could be very vulnerable to selling… and
  4. and of course Facebook (FB) and Alphabet (GOOGL) which make up 17% of the weight, both just off of all time highs.

Here is a great example where the thesis was right for the wrong reasons, and the way to express this view is a loser.  If I haven’t said it in a while, trading is hard.

And here was the trade idea from Sept 13th on the site:

*Trade: XLK ($46.70) Buy Jan 46 / 40 put spread for $1.25
  • Buy 1 Jan 46 put for 1.65
  • Sell 1 Jan 40 put at 40 cents

At this point, more than 2 months on, and a little less than two months to expiration we have a decision to make with the XLK nearly in the same spot from where it was initiated. The XLK has three month support at $46, and considerable technical support at the July breakout level of $45:

[caption id="attachment_68563" align="aligncenter" width="600"]XLK 1yr chart from Bloomberg XLK 1yr chart from Bloomberg[/caption]

The Jan put spread is now worth about 75 cents, down about 50 cents from the purchase price. And with the sector suddenly coming under pressure again the past 2 days it is time to make a decision on whether to cut losses, roll to another bearish trade, or leave as is.

A. If you thought the XLK was getting a tad oversold, then it makes sense to cut losses and look for a better short entry if you think 2017 gets off to a rocky start. We think it will.

B. If you thought that the market continues to make higher highs into the new year, and that Tech stocks get back on their horse, then you would def want to cut losses and possibly look for the XLK to bounce back towards the prior highs.

C. Or you think that today’s selling in Tech is accelerating the recent under-performance and we are likely to see lower lows, then it makes sense to try to wiggle out of the trade near unchanged.

I think it makes sense to give it another day and look to wiggle out. And then rethink the time frame and strikes.