New Trade Alert for Financial ETF – Buy January XLF $21 Call @$3.25 or less
Risk Rating: 2 (1 = lowest 5 = highest)
Below Break Even Probability: 48%
Max Loss Probability: 19%
Take Profit @ $4.00
Stop Loss @ 50% of premium paid
Banking Bounce Buy
After the epic market selloff in the last weeks plus, pockets of stability are attractive as stocks claw back from an emotional unwind.
Let us remember October of last year when psychology changed from negative to positive and recovered all the losses and more after the shakeout.
Bank stocks are still at a discount from pre financial crisis levels though profits and balance sheets are more than impressive. Each quarter the BILLIONS and BILLIONS in profits roll in for the major players, JP Morgan, Wells Fargo, Citigroup, Bank of America, etc…
The Financial Select Sector SPDR (NYSE: XLF) Exchange Traded Fund is a diversified way to participate in the banking and financial sector. This ETF’s is basket of companies that trade like an individual stock.
Financials had fallen from XLF 2007 highs at $38 to extreme crisis lows at $6. The recovery is only now little higher than the $22 midpoint of that fall, with much more upside potential.
The stock market on a whole had gotten back all of the losses and had rebounded to new ALL TIME HIGHS in the S&P 500 just a few short weeks ago.
XLF traded between $23 and $21 for more than a year and has now bounced back above that sideways top that should act as support..
A modest recovery run to $25 would be back to the breakdown point as markets often return.
Only close below the $20.00 level on the weekly basis would negate the bullish multiyear trend.
Instead of buying long shares, a stock substitution strategy limits risk to the premium paid with unlimited upside profit potential. Less capital is required and the risk is less in dollar terms than buying shares outright.
The Options Way: Unlimited Upside Potential with Limited Risk.
A XLF long call option can provide the staying power in a potential larger trend extension. More importantly, the maximum risk is the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the choices and expiration strikes and months. Simply put, traders want to buy a high probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for gain or loss.
There are two rules options traders need to follow to be successful.
Rule One: Choose an option with 70%-plus probability. The Delta is a measurement of how well the option reacts to movement in the underlying security. It is important to buy options that payoff from only a modest price move.
There is no need to ONLY make money on the all but infrequent large price explosion.
Any trade has a fifty/fifty chance of success. Buying options ITM options increase that probability. That Delta also approximates the odds that the option will be In The Money at expiration.
Buying better options is more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.
With XLF trading at $23.65, for example, an In The Money $21.00 strike option currently has $2.65 in real or intrinsic value. The remainder of any premium is the time value of the option.
Rule Two: Buy more time until expiration than you may need — at least three to six months for the trade to develop. Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired premature to the market move.
Trade Setup: I recommend the January XLF $21.00 Call at $3.25 or less. A close below $20.00 on a weekly basis or the loss of half of the option premium would trigger an exit.
This option strike gives you the right to buy the shares at $21 per share with absolutely limited risk.
An 82% option Delta means the option will move much like the stock. The January option gives has four months for BULLISH development.
The maximum loss is limited to the $325 or less paid per option contract. A stop loss is at half of the option value so the risk is $160 if stopped out there.
The upside, on the other hand, is unlimited.
The XLF option trade break-even is $24.25 at expiration ($21.00 strike plus $3.25 or less option premium). That is just $0.60 above XLF’s current price.
If shares retrace just to the previous $25 breakdown base, the option investment would gain more than 33%.