After being relegated to the graveyard of underperformance in 2011, the financial sector — as represented by the Financial Select Sector SPDR (NYSE:XLF) ETF — has experienced an impressive resurrection to claim one of the top spots in terms of sector performance so far this year.
Financials spent the month of February in consolidation mode, but this brief respite might be just what was needed to gather momentum ahead of the next upswing. Traders looking for the financial sector to continue its leading role should consider scouring the space for quality opportunities.
Click to Enlarge Not surprisingly, investment services behemoth Goldman Sachs (NYSE:GS) has followed the trend of its sector by basing sideways for the past few weeks. If it can clear key intermediate-term resistance with a daily close above $118, higher prices look to be in the offing.
Though implied volatility for GS options has drifted lower in recent months, it remains elevated relative to recent realized/actual volatility. The equity’s current 30-day implied volatility sits near 30% (off its October high of 73%) while 20- and 10-day historical volatility rest at 21% and 17%, respectively.
Traders anticipating a continued low-volatility grind higher in GS could sell April bull put spreads. To review, the bull put spread is a vertical credit spread consisting of selling to open a higher-strike put while buying to open a lower-strike put in the same expiration month.
The spread is entered for a net credit, which represents the maximum potential reward and will be held by the trader as profit if the stock continues to trade above the higher strike price at expiration. The maximum risk is limited to the distance between strike prices minus the initial net credit.
Currently, the April 115-110 put spread can be sold for around $1.70 by selling the April 115 put for around $4.35 and buying the buying the 110 put for $2.65. Consider it a bet that GS will remain above $115 by April expiration. If GS is trading north of this level when the options expire, the trader keeps all of the credit collected.
With the potential reward capped at $170, the maximum risk is limited to $330 (115 minus 110 less the premium) and will be incurred if GS is trading beneath $110 by April expiration. That is a drop of almost 6% from current levels. Breakeven for this play is $113.30. The spread will be profitable at expiration if GS is trading above this level.
GS looks to have a key technical support level around $111. If the stock grows weak enough to break below this price threshold, traders might consider exiting at that point to minimize the loss.
At the time of this writing, Tyler Craig had no positions in any of the aforementioned securities.
