This morning, I’m recommending a bearish trade on the Health Care Select Sector SPDR Fund (NYSEARCA:XLV).
The S&P 500 pulled back slightly yesterday, opening at around 3,080 and closing at 3,087.
There is still a lot of bullishness in the market, but at this point, I have recommended enough bullish trades to take advantage of the situation. Given the slight pullback yesterday, I think some downside insurance is the wisest move this morning.
Daily Chart of the S&P 500 — Chart Source: TradingView
XLV is an excellent target for a downside play because the upcoming election could push stocks in the sector down. If we saw a broader pullback in the market, the sector would likely be just as vulnerable. With this recommendation, traders can increase their chance at collecting a profit while also protecting their portfolios against a potential drop in the S&P 500.
XLV Could Struggle as the 2020 Election Heats up
Back in April, XLV had its worst week of the year. It lost 4.4%, and it looked like it was mostly due to the release of several “Medicare for All” plans from Democratic presidential candidates.
The markets are sensitive to big political changes, and the Democratic primaries drew a lot of attention to this issue. It increased volatility for stocks in the sector, and the discussion was even enough to overshadow a strong earnings performance from UnitedHealth Group, Inc. (NYSE:UNH).
Regular readers know I think the healthcare sector is one of the best in the market, however, we’re approaching 2020 quickly, and it’s possible Democratic candidates will bring healthcare discussions back to the forefront.
Regardless of your thoughts on the issue, this discussion has a history of pushing XLV down, and a bearish trade that expires in early 2020 is an excellent way to trade the situation.
XLV’s Resistance at $96
In the chart below, you can see XLV’s drop in April. You’ll also be able to see that XLV is trading above its 50-day moving average (MA) and its 200-day MA — the orange line and the blue line, respectively. Its 50-day MA just crossed above its 200-day MA, which regular readers will identify as a bullish “golden cross” formation.
Daily Chart of Health Care Select Sector SPDR Fund (XLV) — Chart Source: TradingView
But with this downside insurance trade, we are taking a longer point of view. As 2020 approaches, healthcare policy discussions may pick up again, pushing the sector down. The broader market is also at risk of a slight pullback, which would likely spread to XLV.
The golden cross doesn’t concern me because XLV has strong resistance around $96. At the start of December 2018, the stock failed to clear that level. After slowly climbing higher over 2019, XLV still got rejected at just under $96.
Traders have an opportunity to purchase a cheap ratio put debit spread on XLV. For no more than the price of a few cups of coffee, you can set yourself up to profit if the market pulls back.
Using a spread order, buy to open 1 XLV Jan. 17th (2020) $91 put and sell to open 2 XLV Jan. 17th (2020) $87 puts for a net debit of about $0.20.
Note: Be sure you are opening the monthly XLV options that expire on Friday, Jan. 17th, 2020.
About Ratio Put Debit Spreads
A ratio debit spread is simply a way to lower the cost of buying options, as the two options that you sell to open (short) help 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 to execute a ratio 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 XLV at the $87 strike price for every 1 contract that you are short of the XLV Jan. 17th (2020) $87 puts. So, this is inherently a higher risk play.
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