Before Thursday’s downturn — which turned particularly nasty for the world of small caps — the market was experiencing some interesting sector rotation. The resilient leaders of 2013 like consumer staples and healthcare took a week off from their leadership roles, while market laggards like technology and basic materials finally received some love. Consider the following performance chart covering April 23-April 30:
Bulls are touting the resurgence in materials, tech and energy as a positive development. If these more cyclical areas can begin to carry the torch, perhaps the market can overcome the seasonally weak period that is upon us and lengthen its already impressive uptrend.
And yet, the calls for new leadership might be a bit premature. One week of strength is not really sufficient to turn the tides of the multiple months of underperformance that have plagued these beaten-down sectors.
Click to Enlarge Although the tech sector soared to new highs on the heels of the recent buying bonanza, the Materials SPDR (NYSE:XLB) was once again stymied by range resistance. The stubborn ceiling at the $40 zone has been unyielding despite multiple attempts by the bulls to break above it. Alongside the ramp in XLB, its comparative relative strength (CRS) turned up, revealing its recent outperformance. Unfortunately, the newfound strength was insufficient to reverse the overall downtrend in the CRS.
In the end, the past week’s rally in XLB might be yet one more failed attempt of the beleaguered sector to change its stripes from laggard to leader.
Traders looking to play the XLB off of the aforementioned range resistance at $40 could sell June 40-42 bear call spreads for 40 cents. Consider it a bet that XLB will fail to rise above $40 in the coming month. If you’re right, the call spread will expire worthless, allowing you to pocket the initial 40 cents, generating about a 25% return on your investment. The max risk is limited to the spread between strikes minus the initial credit, or $1.60, and will be incurred if XLB rises above $42 by expiration.
If you want to keep a tight leash on the short call spread, consider exiting if XLB breaks above $40. Your loss will end up being much less than the $1.60.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.