XLI – Industrial Strength?

by riskreversal December 23, 2016 2:13 pm • Trade Ideas

A couple weeks ago we highlighted the poor relative year to date performance of shares of General Electric (GE) to many of its peers in the industrial space and the broad market, up only 2%:

vs the XLI, the S&P Industrial etf (of which it is a 10% component) which is up 22% ytd and the S&P 500 (SPX) which is up 11%. One reason for this might be the headwind of the recent strength of the U.S. dollar to company’s 55% exposure outside the U.S. Even with the lack of performance in 2016, shares of GE trade 19x, which ain’t exactly cheap for a very slow growth industrial stock.

GE is the largest component in the XLI, the S&P Industrial Select etf. XLI is up 21% ytd, making GE’s under-performance that much more pronounced compared to the out-performance by Transport components like UNP up 34% ytd, FDX up 30% & UPS up 21%.


The mix of Industrials, Transports and Defense stocks in this etf offers considerable dispersion in performance, but its out view that some of the factors holding back some components might become more pronounced in the New Year. First and foremost, the President-Elect’ has gone after defense spending via Twitter. This looks like a preview of an effort once in office to negotiate better deals on contracts. Whether that’s even possible considering how defense spending is appropriated remains to be seen. Second, tough talk on trade could be a preview of tit for tat trade wars with countries like China. That would not be bullish for many companies in this sector. And finally, the dollar’s rally of more than 5% since the election is likely to remain a headwind for large U.S. multi-nationals like Industrials who rely on overseas for 50% of their sales, and much of their growth.

In the last two weeks, four large components in this sector have offered fuzzy commentary on current visibility:

FedEx delivers mixed earnings report; sees GDP growth of 2.2% in 2017

GE Sets Another High Bar for Itself

United Technologies Gives Mixed 2017 Outlook

Honeywell Offers Tepid 2017 Guidance on Sluggish Demand

We think that Q4 reporting season for this sector will offer more of the same as far as earnings visibility, coupled with the likely continued headwinds of trade rhetoric, especially if the dollar remains well bid.  Playing for a pullback in the broad market makes sense in January as many investors have done their best to hold off on booking profits until 2017 as they expect a friendlier tax regime. But that could mean that too many head for the door at the same time early in the new year.

So what’s the Trade?  

If you agree that some of the large components that have been doing much of the heavy lifting in this space could retrace a bit of their move since the election early in the new year, targeting a pullback to the prior breakout level just below $60 makes sense:

Trade – XLI $63 Buy Feb 63 /59 put spread for $1
  • Buy 1 Feb 63 put for 1.35
  • Sell 1 Feb 59 put at 35 cents

Break-even on Feb expiration:

Profits: between 62 and 59 of up to 3, max gain of 3 below 59

Losses: up to 1 between 62 and 63 max loss of 1 above 63

Rationale: Why target 59? That would be a retracement to the 2015 and Nov breakout level:


Short dated options prices are very near their 2016 low, with 30 day at the money implied volatility very near 1 year lows, making long premium strategies an attractive way to express a defined risk directional view: