By Andrew Giovinazzi
How many times have we seen this story before? Some issue in the EU, although this time it looks smaller, is throwing cold water on everyone's parade. I think the EU holding the line on lending money is a good thing in the long run, and the Cypriot politicians are going to have to make the creditors pay somehow. It is unpleasant but necessary.
This issue is still causing a flight to quality — again not as big — to Treasuries, but overall, this has been muted. That still puts the market on hold for a week or so. Our economic news is still good here, and the Fed is marking time on their bond-buying program. The European issues keep things at a standstill as good news from one side counters the unknown from the other. The trades I look for have the U.S. equity markets maintaining some kind range in the short term.
Right now, I am looking at the Financial Select SPDR /zigman2/quotes/209660484/composite XLF -1.11% . While the name has been moving from around 18.10 lately, it has not been able to break 18.5 during the trading day. With the bank stress tests now behind them, and homes finally selling, the financial sector is in an upturn and has been so since last year as the XLF powered through the euro issues.
While I expect the XLF to go higher this year, I am looking at an entrance now that gives some room with the current woes in Europe. At least for now, the Europeans have given Cyprus until Monday as it is clear they have run out of patience. My guess is we swing around in a range until after Monday, so the trade wants to take advantage of the lack of movement in the meantime.
The biggest advance in option products has been the new weekly options that keep recycling every four weeks. This change has given time spreaders (or calendar traders) a lower-risk way of trading because of the tight terms between expirations. Calendar traders used to have either a rapidly decaying option in the one-week weeklies or use the more standard terms that are about 30 days apart.
The big difference now is the weekly time spreads cost far less to put on and still have solid upside potential. Think of it this way; the tighter the time between terms, the closer the option prices are and less risk in a time spread. After all, if you can buy a calendar for even, there is near no risk at all as long as there are no dividend considerations.
The environment for the XLF today in the two terms I am interested in fits a time spread. For example, the implied volatility in the XLF March 28 weekly is bid 2 points over the XLF April 5 Weekly options. What this does is leave a very cheap 18.5 strike time spread. That would be buying the XLF April 5 weekly 18.5 calls and selling the XLF March 28 weekly calls for around .04. Yes, .04. That is it. Try .04 for the spread first, and if you don’t get filled, work the buy side and then the sell side looking for a .04 debit. As I write this, XLF is trading 18.20.
Now, how should it trade? My guess is that the Cyprus issue will keep the XLF from making new highs by next Friday, but it should keep within this range of 18.0 to 18.5, so in this example, you would let the front month expire worthless and then ride the XLF April 5 weekly 18.5 call higher. That could end up generating a very nice return.