One of the biggest winners following the Donald Trump victory Tuesday are the financial stocks. Exchange-traded fund Financial Select Sector SPDR Fund (NYSEARCA:XLF), which is comprised of the big names like Berkshire Hathaway Inc. (NYSE:BRK.B), JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC), is up about 10% percent just this week.
While a move higher is certainly justified given the likely reworking of the Dodd-Frank Act, it is too far, too fast. I expect a consolidation period is looming in XLF.
Expectations are high for a repeal of the Volcker Rule and a downgrade of the Consumer Financial Protection Bureau.
While some lessening of regulations is assured, I think it will be difficult to remove the safeguards altogether, especially in light of the recent problems at Wells Fargo.
Click to Enlarge From a technical perspective, the breakout has been stunning. Financial stocks are now at levels not seen since May, 2008, prior to the Financial Crisis.
On a shorter-term basis, XLF is extremely overbought. The nine-day RSI reading of nearly 90 is by far the most extreme reading over the past few years. Previous instances when XLF had such high readings proved to be opportune times to take a counter-trend short position in financials.
Click to Enlarge The price action yesterday also showed that a short-term top may be in the offing. XLF rallied to trade up to $21.65 early in the day before selling off. It then rallied to $21.70 midday, only to fail to hold on to the highs and closing below the $21.65 level. This is indicative of buyer fatigue, which many times portends for a reversal pattern in the underlying shares.
While trying to short financial stocks outright has been both dangerous disastrous over the past week, the options market is the perfect choice to structure a bearish trade with defined risk. A put diagonal trade fits the bill nicely.
XLF ETF Trade Idea
Click to Enlarge Buy XLF Dec $22 puts and sell the XLF Nov $21 puts for a 70-cent net debit or better.
The maximum risk on the trade is $70 per spread. The spread is 38 deltas net short at trade inception, which is equivalent to being short 38 shares of XLF. Ideally, XLF closes near the $21 level at the November expiration to achieve the maximum gain.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
