The Financial Select SectorSPDR (
XLF
)
offers a diversified way to invest in the banking sector. The
fund's top 10 holdings include
Bank of America (
BAC
)
,
Wells Fargo (NYSE: WFX)
and
JPMorgan Chase (
JPM
)
, which make up more than 20% of its valuation.
There is plenty of upside potential for the
bankingexchange-traded fund (
ETF
) . A halfwayretracement to the 2007 highs from the 2009 lows
targets an objective of $22, a 41% gain from current levels. A
nearly year-long trading range between $14 and $16 has seen
volatility decline to 52-week lows in abullish sign of an impending
move, and offers a more conservative first breakout target of $18.
Only a close below the $14support level on a weekly basis would
negate the bullish trend.
The $18 target is 15% higher than current prices, but traders
who use a stock substitution strategy could make close to 70%
returns on a move to that level.
One major advantage of using longcall options rather than
buyingshares is putting up much less to control 100 shares --
that's the power ofleverage . But with all of the potential strike
andexpiration combinations, choosing anoption can be a daunting
task.
Simply put, you want to buy a high-probability option that has
enough time to be right, so there are two rules traders should
follow:
Rule One: Choose an option with 70%-plus probability
Delta is a measurement of how well an option follows the movement
in the underlying security. It is important to buy options that pay
off from a modest price move in the stock orETF rather than those
that only make money on the infrequent price explosion.
Any trade has a 50/50 chance of success. Buyingin-the-money
options increases that probability. Delta also approximates the
odds that the optionwill bein the money at expiration. In-the-money
options are more expensive, but they're worth it, as your chances
of success are mathematically superior to buying cheap,
out-of-the-money options that rarely pay off.
For example, with XLF trading at about $15.65 at the time of
this writing, an in-the-money $13 strike call currently has $2.65
in real orintrinsic value . The remainder of any premium is thetime
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 greatestasset when you have completely
limited the exposure risks. Traders often do not buy enough time
for the trade to achieve profitable results. Nothing is more
frustrating than being right about a move only after the option has
expired.
I recommend the XLF June 13 Calls at $3 or less.
A close below $14 in XLF on a weekly basis or the loss of half
of the option premium would trigger an exit. If you do not use a
stop, the maximum loss is still limited to the $3,000 or less paid
per option contract. The upside, on the other hand, is unlimited.
And the June options give thebull trend seven months to
develop.
This trade breaks even at $16 ($12 strike plus $3 option
premium). That is less than $1 above XLF's current price. If shares
hit the conservative breakout target of $18, then the option would
deliver a gain of almost 70%.
Action to Take -->
Buy XLF June 13 Calls at $3 or less. Set stop-loss at
$1.50. Set initialprice target at $5 for a potential 67% gain
in seven months.
This article originally appeared on TradingAuthority.com
A Bet on the Financials Could Bank You 67%
Profits