Banking on Short-Term Pressure for XLF

Heavy call open interest at the XLF March 24 strike is one factor that could keep the shares pinned

Feb 6, 2017 at 9:00 AM
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One of the standout sectors in the post-election "Trump rally" has been the big banks, with investors pricing in their expectations for looser Wall Street regulations (and accordingly juiced-up investing profits). And on Friday, as the administration signaled it would move forward with plans to gut the crisis-era Dodd-Frank legislation, the Financial Select Sector SPDR Fund (XLF) bounced from its 50-day moving average with a gap higher out of the gate.

But XLF is already up 18.6% from its pre-election close, even though the shares have been chopping around in a remarkably narrow range of just barely more than 1 point for the last two months. So it's fair to ask how much more upside is left in the near term (that is, until such a time as the titans of Wall Street actually begin to report their "deregulated" earnings results).

Notably, put open interest on XLF stood, as of Friday morning, at 2.58 million contracts -- in the 92nd percentile of its annual range, per Trade-Alert. We've often observed that investors will buy puts on broad, sector-based ETFs to hedge their acquisition of long equity positions within that sector, which would suggest the near-peak levels of put buying is, in turn, a likely signal of "near-peak" levels of accumulation in bank shares. And traders who bought the "rumor" of Trump's campaign pledge to "dismantle" Dodd-Frank may well be gearing up to the sell the "news" of his executive order on the subject.

Back to that choppy trading range: XLF has repeatedly, since Dec. 8, peaked just short of the $24 level on an intraday basis. If you needed convincing that the repeated stall-out around this level is significant, consider the following:

  • $24.74 = 20% below June 2007 all-time high
  • $23.49 = XLF's 2007 close
  • $24.10 = February 2008 high
  • $23.85 = 5 times March 2009 low
  • $23.79 = 50% return from February 2016 low

Then there's the matter of XLF call open interest, which -- similar to put open interest -- is more abundant than usual right now. There are just shy of 2 million XLF calls open (an accumulation that registers in the 82nd annual percentile), and roughly 18% of those are docked at the March 24 call. So we can add the prospect of near-term options-related resistance to our above list of reasons why $24 has become such a sticking point for XLF.

This is not to suggest that an all-out plunge is imminent for the financial fund, but simply that a continued consolidation or pullback from here would be unsurprising. What would be somewhat surprising would be a pullback that carries XLF below the $20 level, which easily rivals (and perhaps exceeds) $24 in its significance. This round-number price point was the site of XLF highs in September 2008 and July 2015, and played the role of resistance from August-October 2016. It's also home to XLF's 10-month moving average, and -- perhaps most crucially, given our earlier discussion about recent XLF share accumulation -- the shares settled squarely at $19.99 on Nov. 8, just before the presidential election results.

xlf daily price chart 0203

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