One of the most important economic reports last week was the Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI), which indicated that the manufacturing sector was in contraction.
Despite that news, industrial stocks, as represented by the Industrial Select Sector SPDR Fund (NYSEARCA:XLI), are performing well. It’s possible that, since high level trade talks between the U.S. and China have started back up, traders are feeling more optimistic about industrial stocks.
Still, I think there could be more trouble around the corner, and if manufacturing is slowing down, a downside trade on XLI may act as good insurance.
Follow the Manufacturing PMI
Trader’s have good reason to be optimistic about XLI. Since the start of 2019, it has gained just over 20%, meaning it has out performed the rest of the market. This might be because American manufacturers like 3M Company (NYSE:MMM) and United Technologies Corporation (NYSE:UTX) have managed to offset tariff impacts with higher pricing.
These companies have proved capable of profiting during the trade war, and they will ultimately benefit if it is resolved, but now that the entire sector is in contraction, I think investors should be cautious. After all, we’ve seen this trade war go back and forth for the last two years. How can investors be sure this new round of talks will lead to something?
Old Resistance Levels
Before its pullback at the beginning of August, XLI had been making higher highs. As you can see below, its up-trending resistance levels started at around $78.
Daily Chart of Industrial Select Sector SPDR Fund (XLI) — Chart Source: TradingView
XLI dropped below its 50-day moving average (MA) at the start of August, and it was acting as resistance until last week, when XLI broke higher. Now XLI’s next resistance level is at around $78.
It’s struggling to stay above $77 this morning, and I think the path of least resistance is below its 50-day MA. At the very least, XLI may restest those levels for support.
Using a spread order, buy to open the XLI Dec. 20th $76 put and sell to open the XLI Dec. 20th $72 put for a net debit of about $1.10.
Note: Be sure you are opening the monthly XLI options that expire on Friday, Dec. 20, 2019.
About Put Debit Spreads
A debit spread is simply a way to lower the cost of buying options, as the option that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this put debit spread is a way to lower the cost of buying bearish put options. Many brokers will require the use of margin and/or a set amount of reserved capital to execute a debit spread; contact your broker directly for specific requirements.
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