Investors returned from the weekend to a bloody open. Stocks across the board experienced a notable down-gap amid further anxiety surrounding last week’s failed passage of a bill representing President Trump’s first attempt to replace the Affordable Care Act.
The recent selling has been the most significant downturn investors have faced since Trump’s historic election ignited a monster rally in equities. The large-cap-laden S&P 500 is now some 3.6% off its highs while the Russell 2000 is down some 6%. It’s certainly not the most gut-wrenching swoon we’ve ever seen, but considering the low volatility that’s dominated the landscape since November, this qualifies as a noteworthy slip.
The blood in the streets seen Monday morning was sufficient in bringing fear back into the building. The oft-watched CBOE Volatility Index jumped to a four-month high at $15. And that means option premiums are expanding due to high demand for derivatives.
But don’t panic — the markets are already starting to recover. Rather than losing your head like the other lemmings, how about initiating a few trades designed to capitalize on the fear?
Behold, three trades to buy the “blood in the streets.”
“Blood in the Streets” Trades: Financial Sector SPDR Fund (XLF)
One of the hardest hit areas over the past week has been the Financial Select Sector SPDR Fund (NYSEARCA:XLF). As of Monday’s open, the financial sector was 9% off its highs. Technician’s will note that’s a pebble toss away from correction territory (defined as a 10% peak-to-trough drop).
Prudence demands more optimism in any sector perched in a longer-term uptrend following a 9% drubbing. These larger dips don’t arise that often. What makes the setup particularly attractive is the ramp transpiring in implied volatility. XLF’s implied volatility just ramped to 37%, which is a nine-month high.
If you’ve been patiently waiting for a time when you’re finally getting paid to take risk, wait no longer. To capitalize on the elevated fear, as well as the likelihood that XLF rebounds over the coming month, sell the May $23 put for around 55 cents.
“Blood in the Streets” Trades: PowerShares QQQ Trust (ETF) (QQQ)
While some sectors are receiving more than their fair share of pain, others, like the technology sector, are weathering the selling storm quite nicely. At Monday’s open, the PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ) had only fallen 2% from its highs.
That’s some relative strength. And, yes, it hardly qualifies as “blood in the streets.” But perhaps that’s what makes a bullish trade in tech stocks so attractive. Some say that the stocks that hold up the strongest during a downturn are those with the best chance at outperforming when the selling pressure finally abates.
If you think the market swoon bottoms sooner than later, and that QQQ is well positioned to pop during the next advance, sell the May $124/$120 bull put spread for 42 cents credit. The spread has the potential to deliver an 11.7% return if QQQ sits above $124 at expiration.
“Blood in the Streets” Trades: SPDR S&P Retail ETF (XRT)
The SPDR S&P Retail (ETF) (NYSEARCA:XRT) rounds out today’s trio with an interesting little setup. For starters, XRT has the highest implied volatility rank of every major market sector. That means its options are theoretically offering the most “juice” for premium sellers.
From a price perspective, XRT is exhibiting some serious relative strength today. Though the sector gapped down with its brethren, it is already up 0.63% on the day in early morning trading.
The fund is in a downtrend, but some significant support levels loom closely near the $40 and $39 levels. Traders looking for a high probability, contrarian trade, could consider selling the May $39 put for 47 cents. If XRT sits above $39 at expiration, you will capture the 47 cent premium. And if it’s below $39, you will be obligated to buy 100 shares at an effective purchase price of $38.53.
At the time of this writing, Tyler Craig held short puts in XLF.