XLV – Health Scare

by Dan March 7, 2017 1:53 pm • Trade Ideas

This morning:

Hard for any consumer to argue this point, but the devil will be in the details and we know those details don’t emerge all at once in DC, they come in the form of tape bombs (think stock volatility).

Drugs stocks got hit on that tweet, as one might expect, but have since rallied off of their lows, and the XLV, the S&P Healthcare etf is trading at session highs as I write:


Not bad price action at all, but to my eye, $76 appears to be massive near term technical resistance:

XLV 1yr chart from Bloomberg

It’s a slightly different picture looking at the 5 year chart, with the etf having just broken above the downtrend that has been in place from the mid 2015 all time highs, after having bounced off of the long term uptrend that had been in place from the mid 2012 lows:


Despite the decent price action, and the potential of a breakout above the downtrend, I’m far more inclined to play for a re-test of long term uptrend back towards $70, given the headline risk after such a sharp rally (up nearly 10% so far in 2017). Options prices are very near two year lows (x out that bad print last year):

XLV 1yr chart of 30 day at the money implied volatility from Bloomberg

So What’s the Trade?

XLV ($75.30) Sell the April 70 puts, Buy the June 75 puts (diagonal calendar) for 2.00
  • Sell 1 April 70 put at .20
  • Buy 1 June 75 put for 2.20


Mark to market profits and losses on April Expiration: The trade starts as -35 deltas, the position will gain if the etf goes lower before April expiration, and lose if the etf goes higher. Below 70, before April expiration the trade maxes out and can’t make more than $3.00, but if the etf is higher than 70 on Arpil expiration the short puts will expire worthless and the June puts can be further spread in those 2 months remaining.

Rationale – We’re able to buy really cheap vol for a consolidation in the these names out to June, and make it even cheaper by selling an April put that will expire 2 months before the June 75s. If the etf goes lower in the meantime the trade will do well, a close near 70 on April expiration is ideal. If the stock goes higher the position will have mark to market losses the short April puts will expire worthless and only minimally help (.20) against losses in the June puts. Ideally the April puts expire worthless with the stock lower towards that strike. We could then continue to whittle away at the overall cost of the position by selling May or June puts against the long June 75 puts. If the etf breaks out from here we’ll keep the entire position on a short leash as it’s -35 deltas.