November has brought a mind-boggling market comeback, defying all fundamentals, signs of a looming recession, and warnings from major U.S. retailers about weakening consumer spending. It is time for investors to start registering profits on their bullish bets and to prepare for a pullback. The Financial Select Sector SPDR (XLF) ETF is showing signs of a stalling rally. A 3-year weekly chart give us a nice 30,000-foot view on how the financial sector has been trading in the recent past. Note that $36 has become an area of strong resistance and XLF was rejected here five times since May 2022. Markets are due for a pullback and this level can serve as resistance once again for the entire financial sector. Finding a stock to trade “A rising tide lifts all boats” and vice-versa is my mantra here. If you switch to a 6-month daily chart of any of the financial stocks, you will notice that they all look very similar to XLF. I am using Visa (V) as an example, but you could use something else like Mastercard (MA) and the set-up will be exactly the same. To confirm my bearish bias on V, I am using the following indicators: RSI (Relative Strength Index): Using the RSI indicator is straightforward. If it moves above 70 that means the stock is overbought. Once overbought, a trader needs to wait for the stock to drop below the 70 area for a bearish setup to form. Note that V has just touched that 70 area (although it may take a day or two to drop below 70) DMI (Directional Movement Index): When the DI+ (green line) is above DI- (red line), the stock is in an uptrend. However, when the DI lines start changing direction, that indicates a possible change in the current trend. This is exactly what we are seeing in the chart above. The trade set-up With a bearish directional bias in place, all I need to do is find a suitable options structure to take a bearish trade. The trade structure I am using here is called a “bear put spread” also known as a “put debit spread”. To construct my bear put spread, all I need to do is buy a $255 put and sell a $250 put as a single unit. Most trading platforms will offer a bear put spread (or long put spread) as a trade type and automatically construct the trade for you. All one needs to do is make sure that they pick the right strikes and expiration dates. Here is my exact trade setup: Buy $255 put, Dec. 22 expiry Sell $250 put, Dec. 22 expiry Cost: $2.50 A nice thing about buying ATM (at-the-money) spreads, is that the math becomes very easy. ATM spreads can usually be bought for half of the width of the strikes. Since the width of our spread is $255 – $250 = $5, I can buy the spread for $2.50. Profit Target If V is trading at $250 or below on expiration date, this trade will double my money and return a 100% ROI on money invested. A very important part of any profitable trading system is that it needs to have positive expectancy. That means the winners need to add up to more than the losers. For me to create positive expectancy with this trading strategy, I will close this trade if I lose 50% of my investment (i.e $1.25). By simply doing this, every winner will cancel out two losing trades. — Nishant Pant, founder: https://tradingextremes.com , author: Mean Reversion Trading DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
