The options market rarely gives us gifts, but right now it may be doing so.
Materials usually don’t make headlines. The Treasury Secretary’s efforts to rein in the long end of the interest rate curve are notable for receiving attention that this week’s sharp moves by Moderna and Merck did not. But so are the potential inflationary effects of policymakers’ restraint on interest rates.
Materials was one of the best-performing sectors this week, and (well) it’s also significantly outperformed the S&P 500 so far this year, up nearly 17%. Some of this has to do with building AI infrastructure through the consumption of copper, chemicals, and construction materials. Part of that is tied to precious metals, backed by the harsh reality that policymakers are reluctant to fix fiscal problems, preferring instead to monetize them.
Now, what makes this setup particularly interesting for option traders is that the implied one-month at-the-money volatility is State Street Materials Select Sector SPDR ETF (XLB) Cheap at just over 14%. Over the past five years of outlook, that number has averaged 19.5%, been as high as 47.25%, and as low as 11.8%. In other words, option prices in this sector are closer to the five-year low than to the five-year average.
Why is it important?
When you use options to bet on the direction of a stock, your risk is limited to the premium you pay. The lower the premium, the lower the risk. Lower premiums mean lower risk and better risk/reward. Another benefit? There’s no need to be flashy.
For long option positions, there is no need to use complex strategies, whether outright directional bets or long gamma strategies. The usual argument for using a spread (trying to offset a high premium by selling an option against a purchased option) no longer makes sense, so just buy the option.
Want to make a bullish bet? Buy the call. A September 52.5 at the money call costs about $1. That’s less than 2% of the current stock price. That’s the biggest risk. A rise to $53.5 would give call buyers breakeven on the upside, giving them just 1.9% more than Thursday’s closing price over four weeks.
Given that XLB rose 1.67% on Thursday, a 2% rise or fall in the coming weeks is not only unlikely, but very likely. If XLB rises by more than 2%, this trade is a win. If XLB falls by more than 2%, the risk of a long call is less than buying the stock.
By the way, if you don’t agree with the bullish thesis in the material and want to go short, you might be better off buying the September 52.5 put, which is about the same price as the call, rather than shorting the ETF. Even contrarians may prefer to risk less than 2% between now and the September expiration.
Disclosure: (none)
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