I have been talking about how the financial stocks need to show continued strength to lead the market higher in recent weeks. After going hunting for an option trade, I want to expand on those thoughts.
The Financial Select Sector SPDR ETF (XLF, $24.95, flat) continue to make a nice recovery following the mid-December test to $23.55 and the 50-day moving average.
I have talked about a possible run to $30 for the index coming in 2015. This is an aggressive price target, but it is one that can be achieved, as the 2007 high reached $32. The 10-year chart below also shows the solid uptrend following the 2009 low of $5.32.
It would be hard to complain if you bought the XLF in the single-digits and it had rallied roughly 20% from the February low just above $20.
XLF took 10 months to make the move from $20 to yesterday’s high, north of $25.
To find a suitable option trade, I looked at the XLF June 26 calls (65 cents, flat). These XLF options have over six months before they expire and would be worth at least $1 if XLF shares reach $27 by mid-June 2015. The return would be roughly 50% from current levels.
These aforementioned call options would double from current levels, or be worth at least $1.30, if XLF shares trade to $27.30, technically, by mid-June 2015. The options would be $1.30 “in the money.” This would require shares to move nearly 10%, but the payoff on the options would be 100%.
A 10-lot contract would cost $650 at current levels. One contract would cost $65. Buying 1,000 XLF shares would cost $25,000 at current levels, while 10 contracts gives you control of 1,000 shares for $650. Buying 100 shares would cost $2,500, while one contract gives you control of 100 shares for $65. This is the beauty of leverage, as a 10% stock move provides you an opportunity for a 100% return with the right option.
The XLF Sept. 26 calls (90 cents, flat) would provide a nine-month time frame for the XLF to reach $28. If this level is reached by mid-September, these calls options would be worth at least $2. XLF shares would have to rally 12% from current levels to possibly get a double, but these options also provide three extra months of time premium.
As you can see, both options offer an attractive risk/reward set up if shares do reach $27 – $28 over the next six to nine months.
These trades require patience and could provide a good way to ignore the market noise, as the goal would be to hold both options into June and September, respectively.
Near-term support is at $24.75 – $24.50. A break below $24 – $23.50 and the 50- and 100-day moving averages would suggest that a top is in. Positions could be closed to avoid further losses if these levels come into play.
If the financial sector can stay strong, I like both of these XLF call options at current levels.
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