For the SPDR S&P Homebuilders (ETF) (XHB), 2014 was a year of base building. Rather than following U.S. blue chips into record territory time and time again, homebuilding stocks spent the year in consolidation mode.
While naysaysers may be citing its lack of energy as a negative omen, optimists can argue that XHB’s ability to maintain all the hard-fought gains of the past three years is a good sign.
In technical analysis lore, sideways bases like the kind formed in 2014 by the XHB ETF — a broad homebuilding ETF that holds stocks such as Lumber Liquidators Holdings Inc (LL) and Toll Brothers Inc (TOL) — often serve as launchpads for the next advance in a stock’s uptrend. The old phrase “the longer the base, the higher in space” suggests stocks that finally break out of long-term bases often enjoy a rocket-like rise higher.
The year-long base in XHB is easily spotted in the following weekly chart.
Over the past few months, XHB has enjoyed a sharp ascent from the lower end of the base to the upper end. The fourth-quarter surge has succeeded in turning the ETF’s relative strength trend from down to up. The following daily chart shows a zoomed in view of the XHB ETF with the comparative relative strength study below.
Notice how the trend in the CRS recently reversed. If the relative strength continues, XHB is poised to breakout of its base in early 2015. Watch for a breach of $34.50 to confirm.
How to Trade the XHB Breakout
Traders looking to exploit the coming breakout could purchase a June $34/$37 call spread for $1. By going out to June, you give yourself plenty of time for XHB to complete the base and climb to $37.
The max risk is limited to the initial $1 debit and will be lost if XHB sits below $34 at expiration. The max reward is limited to the distance between strikes minus the net debit, or $2, and will be captured if XHB rises above $37 by expiration.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.