There is extreme bearish sentiment sweeping the markets right now. The CPI blew away estimates, leaping 1.1% with core prices climbing 0.3%. These figures indicate that inflation is on the rise, remaining a real threat to the economy.
Normally, this would trigger rate hikes by the Fed to stem the inflation risk. However, the state of the economy currently, is a great impediment to the Fed’s need to raise rates. The Fed is placed in a perfect catch-22 situation; raise rates — kicking the already beat down market deeper in the hole — or stand aside and watch inflation potentially spiral out of control. This dilemma is reflected in the market by the recent spike ups and smack downs occurring almost daily. The two primary sectors in the middle of this perfect storm are financials and energies.
This article will focus on 3 potential option trades in the Financial sector, which stands at the center of all of this. The Financial ETFs fit this criteria perfectly, particularly the Ultra Pro Shares due to the very high recent volatility in this space.
The Ultra Short Financial Pro-Shares SKF is an ETF that is tied inversely to the Dow Jones Financial Index which is an index consisting of stocks in the financial sector. ^JPM^ has the highest weighting within the index, with the banking sub sector making up 33% of the same. This ETF is built by using swaps which magnifies your returns/losses by 2 times, so it’s a highly leveraged tool. As you can imagine, it has been in a massive up move lately, as the financial sector dives.
Yesterday, it hit a high of 210, but today it has fallen dramatically over 10% or $23.00 as this is written. This move is being attributed to positive quarterly results from ^WFC^. This seems to be a shaky foundation for the upmove in financials, in light of the current situation in this space. Regardless of your directional bias, here are 3 specific option strategies to take a look at on SKF.
You can imagine the volatility in the options with these sharp moves. The 6-month average volatility on SKF August options is 75 and it has spiked up to 124.
1. If you’re bullish on SKF, which means you are bearish on the financial sector, believing this up move today will be short lived. A Call Back Spread looks enticing. Right now, you would purchase 2 October 210 Calls SKDJB currently trading at $26.40 and sell 1 October 195 Call SKDJM, now trading at $31.20. This trade takes a total investment of $2160.00, has a maximum risk of $3660.00 and an unlimited potential on the upside.
2. If you’re bearish on SKF, believing the upmove today is the start of a positive change in trend for the financial sector, and a start of a down trend in SKF, here’s a simple strategy for you: Buy an October 170 Put SKFVD now trading at $28.50. Your max loss on the trade is limited to the $2850.00 paid for, the Put and gains are unlimited. 170 is very close to the current trading price, is well above the 50 and 200-day Simple Moving Averages and will be hit with even a mild continuation of the present pullback.
3. If your bias is neutral on SKF, a Put Ratio Spread would be my strategy of choice. Specifically, buying 2 October 180 Puts SKDVX at the current price of $34.50 and selling 0ctober 170 Put at $26.30 SKFVD. The max gain on this trade is $5620.00 and the total investment is $3620.
These strategy presentations assume that you are willing to risk $5000.00 and have a 3-month time frame. Remember, all option trading has inherent risks, be sure to fully understand these risks prior to delving into the option market.
David Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.