Take Big Profits When this Financial ETF Retests Support

XLF could head lower if interest rates get cut

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This morning, I am recommending a bearish trade on the Financial Select Sector SPDR Fund (NYSEARCA:XLF).

Last week, the Bureau of Labor Statistics (BLS) reported that the U.S. created 224,000 new jobs during the month of June. Since analysts were only expecting 162,000, this was a bullish surprise.

It was good for the financial sector too, which was already bullish after many larger banks passed a “stress test” from the Federal Reserve.

But if the Fed cuts the overnight rate in July, interest rates could fall even further than they already have. That would be bearish for the financial sector in the long term, and I’d like to be prepared with a downside trade on XLF.

Traders Still Expect a Cut

Looking at the chart CME FedWatch tool, we can see investors pricing in a 93% chance of a rate cut in July. While a cut to the overnight rate may be bullish for the economy, it also lowers interest rates.

CME FedWatch Tool Projections for July 31 FOMC Meeting

The CBOE Interest Rate 10 Year T Note (INDEXCBOE:TNX) is still hovering around 2%. Long-term loans and mortgage rates track the TNX closely, and it usually falls when the overnight rate is cut.

Lower interest rates generally cut into banks’ profits. With earnings season approaching, investors may start to leave the sector before lower rates start eating away at profits, and that would push share prices lower.

The recent jobs report from the BLS may make the Fed think twice about cutting rates on July, but investors don’t seem to think so. I want to have a bearish trade on XLF just in case.

Retesting $27 as Support

XLF started to head higher last week, but it ran into resistance just under the $28.50 level. From here, it could move to retest old support at $27, or it could see if old resistance at around $27.50 will serve as support. That gives us a good range for a put debit spread.

Daily Chart of Financial Select Sector SPDR Fund (XLF) — Chart Source: TradingView

While we may see some bullish action from the financial sector as earnings season starts up, I would expect low interest rates to keep the sector from rising too much. In the short term, the technical picture favors a bearish trade, which is why I’m recommending a put debit spread.

Using a spread order, buy to open the XLF Sept. 20th $28 put and sell to open the XLF Sept. 20th $27 put for a net debit of about $0.30.

Note: There are several September expirations available for XLF options. Be sure you are opening the monthly options that expire on Friday, Sept. 20, 2019.

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