As the market ticked up to new all time highs in March we focused on a couple of sectors we thought were ripe for a pullback. We positioned bearishly in XLU, XLV, and XLI with defined risk. In the last week we’ve seen a return of some downward volatility but as we’ve seen today, with buyers lurking on even small dips and the VIX only slightly higher from historic lows we’re not exactly turning on a dime into any sort of instant correction. I wanted to check in on these 3 trade ideas to see how they’re doing and what can be done from a trade management perspective. First, let’s look at the worst one, XLU. Here’s the original trade idea and rationale at the time. From March 3rd:
XLU ($51.15) Buy April 51 / 47 put spread for $1
- Buy 1 April 51 put for 1.20
- Sell 1 April 47 put at 20 cents
Rationale – The utility stocks ripped in February on a technical breakout. But we’re heading into a rising rate environment and positioning XLU to reverse some of the recent games makes sense in that environment. The 1 to 3 payout potential is nice with volatility fairly low. On the downside 49 is a realistic area to target and perhaps a place to take profits. On the upside, last Summer’s highs near 53 can be used as a stop.
In that same post we identified 52 as technical resistance and were looking for a move to 49. What we’ve gotten instead is a sideways move. The lowest XLU has been in the meantime is about 50.50 and it has yet to hold a move above 52. So we’ve been right about the utilites running out of steam, but wrong that that would mean a pullback. With the XLU now slightly higher at 51.55, this spread is about a 50% loss.
So what to do?
This consensus on interest rates and therefore bond proxies like XLU is… complicated. We know we’re in a rising rate environment, but no one expects the FOMC to be in any sort of hurry. Consensus is about 3 rate hikes in 2017, and barring any economic surprises, consensus will probably be correct. Therefore utility stock performance is probably more correlated overall with broader stock market performance than bonds for the time being. They will likely out or under perform on a relative basis based on rate moves, but as long as we remain in a situation of gradual interest rate hikes on schedule the bigger factor will be what equities are doing. Therefore these stocks are stuck in the same low vol, small moves environment as other equities until they are not. And with less than a month until expiration it’s probably best to be disciplined at this 50% loss stop and not let this turn into a complete loss with a breakeven at 50 with only a few weeks left.
The next trade idea to look at is in XLV, the healthcare SPDR. Here was the trade idea and rationale at the time, from March 7th:
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
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.
With XLV now slightly lower at 74.50 this is worth about what was originally paid. The April 70 puts are worth .15 and that 5c decay has been less than the decay we’ve seen in the June 75 puts. The decay in June has been offset by the short deltas leaving the June 75 puts at the same price originally paid. As far as trade management this is probably in good shape but it has become and even more aggressive short delta position as it is now -45 deltas vs the -35 at entry. Therefore a roll to offset some of those deltas and reduce premium at risk makes sense, but we’d like to see the etf a little lower to do that roll. If we see the etf at 73 we’ll roll to reduce deltas. On the upside, if we see a move above 76 we’ll take the position off for a small loss.
The final trade idea to look at is in the industrial stocks and the XLI SPDR. Here was the original trade idea and rationale, from March 9th:
As we head into April and Q1 earnings season with stocks near highs, if we don’t get clarity on any timing of infrastructure spending and tax reform, some of the optimism shown by business executives might result in forward guidance that is less clear than mud.
So what’s the trade?
XLI ($65.50) Buy the June 65/60 put spread for 1.30
- Buy 1 June 65 put for 2.00
- Sell 1 June 60 put at .70
With XLI now 64.15 this is worth about 1.65 mark to market. Since it is out to June we can be patient. 62.50 is a good spot to re-assess if we see any continued selling, the trade is likely to a double at that point. On the upside 65 coincides with the 50 day moving average and the trade would likely still be worth about what was paid, that’s a good stop to keep in case we see buyers take the market back towards highs.