Volatility is not done with us yet. It ain’t going down without a fight, states Sean McLaughlin of AllStarCharts.com.
At the time I’m writing this, CBOE SPX Volatility Index (VIX) is +15% on the day and +31% since Monday’s close. This has me back on the hunt for some premium selling opportunities.
And an ETF on our radar that checks the boxes of elevated premium, potential rangebound trading action, and a good fade opportunity is the Industrial Select Sector SPDR Fund (XLI).
Check out this chart of XLI:
It’s a nice little pullback over the past two weeks that the team here feels is a bit overdone. And that 97 level on the downside has proven to be a pretty significant level of support over the past year. There was a brief freak out in late February that saw XLI trade below 97, but it quickly recovered and rocketed higher.
As markets have gotten a little dicey over the past few days and XLI has sold off, we’ve seen implied volatility creep higher in XLI options. This means there’s more premium for us to sell!
This sets up a great opportunity to fade this selloff and bet on some rangebound action.
Here’s the Play:
I like selling an $XLI May 97/105 Strangle for approximately $2.85 net credit.
This means I’ll be naked short both the 97 puts and the 105 calls. Naked short options also means this trade will require elevated margin to hold the position. (If I wanted to minimize the margin impact, or maybe just define my risk, I could add long further out-of-the-money puts and calls, turning this trade into an Iron Condor.)
Here’s how the risk profile of the strangle shapes up:
As long as XLI stays above 97 or below 105, we should have no trouble hitting our profit target. I’ll look to exit this spread for a profit when I can close it down for a $1.40 debit.
This would represent a capture of 50% of the original premium collected, and this is my best practice when holding short strangles.
Thanks to the nice premium we’re collecting up front, we get a little room to be wrong. So I’ll continue holding out for my profit target unless we see XLI close below 96 or above 106. Any close outside this range tells me that our fade/rangebound thesis is wrong and I’ll want to close the trade down and move on to better opportunities. In all likelihood, in this situation the trade will incur a loss. But not necessarily. Depends on the timing of the breakout.
Either way, win or lose, I’ll be closing it down.
Learn more about Sean at AllStarCharts.com.
