Transportation Stocks Are Set to Struggle

This morning, I’m recommending a bearish trade on the iShares Transportation Average ETF (NYSEARCA:IYT).

I have been bearish on transportation stocks, particularly rail stocks, since July. At the time, year-over-year rail traffic, as reported by the Association of American Railroads (AAR), was lower. In the AAR’s most recent report, year-over-year rail traffic is lower again.

But IYT’s holdings are made up of more than just rail stocks. In fact, just over 8% of its weighting is shares of FedEx Corporation (NYSE:FDX), the all important bellwether stock.

FedEx and the Global Economy

Everyone knows FDX is a bellwether for the global economy. Because it reports earnings earlier in each quarter than most shipping companies, it clues investors in to business spending patterns.

FDX’s last reported earnings in mid-September, and the results were not good. While revenue climbed by 2.8%, earnings declined by 15.2%. Concerns about future business spending pushed the stock down by 13%. FDX released new guidance that cut its 2020 expectations.

While FDX’s report is a warning sign about the health of the economy, it is also — more obviously — a warning about weakness in the transportation sector.

The FDX report didn’t hit the broader sector right away, but last week stocks started to fall, and based on the technical picture, IYT will continue to struggle.

A Lot of Potential Resistance

In the chart below, you can see IYT finally fell last week, along with the rest of the market. Now the stock is at a turning point. While support at around $174 has held strong, the stock could run into resistance at around the $184 level and head lower. And this morning, it seems to have been rejected before even crossing above $180.

Daily Chart of iShares Transportation Average ETF (IYT) — Chart Source: TradingView

If IYT is rejected at a lower level, it could drop below resistance as pessimism mounts. This is a volatile time of year, and I wouldn’t rule out another drop below the $174-$175 range. Because of the potential bearishness, I’m recommending a ratio put debit spread.

Using a spread order, buy to open 1 IYT Nov. 15th $175 put and sell to open 2 IYT Nov. 15th $165 puts for a net debit of about $0.20.

Note: Be sure you are opening the monthly IYT options that expire on Friday, Nov. 15, 2019.

About Ratio Put Debit Spreads

A ratio debit spread is simply a way to lower the cost of buying options, as the two option(s) that you sell to open (short) helps offset the cost of the option that you buy to open. Therefore, this ratio put debit spread is a way to lower the cost of establishing a bearish put option trade. Many brokers will require the use of margin and/or a set amount of reserved capital and/or a margin account to execute a debit spread; contact your broker directly for specific requirements.

Because you are short a naked put in this ratio put debit spread, the risk is that you could be obligated to buy 100 shares of IYT at the $165 strike price for every 1 contract that you are short of the IYT Nov. 15th $165 puts. So, this is inherently a higher risk play.

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