XLV Option Bull Takes Timely Profits

How one short-term options trader won big on XLV's rise to new highs

Jun 26, 2017 at 2:23 PM
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As of this writing, senators still have some haggling to do in order to ensure the passage of a revamped healthcare bill next week -- but the action in the Health Care Select Sector SPDR Fund (XLV) of late suggests traders have already priced in a legislative win for the pharmaceutical and insurance stocks that comprise the exchange-traded fund's biggest holdings. The ETF broke out to a gain of more than 3% on the week, and traded above the $80 level for the first time ever.

What's more, put open interest on XLV fell off a cliff when June-dated options expired, dropping from roughly 291,000 contracts on June 16 to the current total (as of Friday morning) of 123,660 contracts, which ranks lower than 99% of other such readings from the past year (per Trade-Alert). In fact, calls are now outnumbering puts on XLV for the first time since late March.

Helping the case for call open interest was a busy day for XLV's July 79.50 strike last Tuesday, June 20, when upwards of 9,500 contracts were traded -- most of which were bought to open, per data from the major options exchanges. And while the July 79.50 call still carries peak open interest for XLV of 28,380 contracts, it looks as though Tuesday's flurry of call buying gave way to a rush of call liquidations on Thursday -- when volume at the July 79.50 call strike again exceeded 9,500 contracts, with open interest tumbling significantly overnight.

Based on the volume-weighted average price for the option on both days, an XLV July 79.50 call purchased on Tuesday and sold on Thursday would have yielded a quick profit of 150%, during a three-day span where XLV shares advanced 2.7%. Rising uncertainty over the fate of the healthcare bill was a boon for option buyers, as implied volatility on the option rose from 10.7% at Tuesday's close to 12.8% at Thursday's close.

And from a broader perspective, Thursday was an ideal time to close out an XLV long, as the fund marked a second straight daily close above its upper Bollinger Band, while its Relative Strength Index (RSI) simultaneously jumped above 82 -- and so far in 2017, such occurrences have preceded short-term drawdowns and/or consolidations in XLV shares. Plus, with the ETF ramping up to record highs last week, we'd humbly suggest that any further healthcare headlines out of D.C. could spark a "sell on the news" reaction.

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Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, June 25.

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