You can’t judge a book by its cover. And in the case of the stock market, you can’t judge a sector by name alone, so the options market can present some attractive opportunities. Let me explain.
All market sectors have some degree of diversification. Industries and sub-industry groups are different and may respond differently to broader sector factors. In some cases, these differences may be distinct but affect the same product in some way. Consider the Energy Selection Sector Index. This includes companies across all of the upstream (E&P), midstream (pipelines and logistics), downstream (refining and marketing) industries, or integrated oil companies and services. Global power relations may give one industry an advantage over another within its sector, but these are different positions on the same playing field. The consumer discretionary sector includes a wide range of unrelated products and services, but they all have one thing in common: demand. When consumers are in a pinch, they cut back on spending. It doesn’t matter if you sell cars, refrigerators, yoga apparel, cruises, coffee, games, etc. What these all have in common is that consumers need a little extra cash in their pocket to purchase them, and that’s more than enough.
The most idiosyncratic and internally inconsistent sector is communication services. On the surface, what unites them is that companies “facilitate communication” or distribute content, but that definition is so broad that it groups companies with fundamentally different economics. Sectors include: alphabet and metawhose revenue comes from digital advertising, AI, data, and cloud (especially in Alphabet’s case). What do these two people have in common? verizon, AT&Tand T-Mobilewhich operates a regulated, capital-intensive telecommunications network? or Netflix, disney and fox In that respect?
Its seemingly haphazard structure may be one of the sector’s strengths, offering some diversification in a somewhat compromised basket and concomitantly low volatility. One might argue that a broader index offers better diversification and slightly less volatility, given that the sector has underperformed the S&P by more than 14% year-to-date.
State Street Communications Sector ETF Year-to-date
Perhaps, quietly, communications is starting to make up for some of this year’s underperformance. With the S&P mostly stuck this quarter, the telecom sector has quietly gained bids, generating a total return of nearly 6.5%, enough to beat the S&P’s total return by more than 5%.
XLCthe Telecommunications Sector ETF has bounced off the $105 level twice in the past few months, giving us some lines to draw sand from and set options trades on. Specifically, the spread risk reversal of January’s 105/115/125 calls, selling the $105 exercise put, buying the $115 call at the level where XLC bounced, essentially selling the $125 call where we are now, giving us room to reach new highs. The rally should go on.
This structure essentially allows you to go long the $115 call for just over $0.30, a significant discount from the $4.35 price. Of course, in exchange for cutting costs, your upside would be limited to $125, and you might be forced to buy the stock at $105 if it falls below that level. But by selling these two options, you have effectively bought a $10 wide call spread for just $0.30. Of course, be aware that shorting a put ties up some margin, so there are additional costs associated with this structure.
Disclosure: Tidal owns/holds all securities mentioned in the article.
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