How to Swing Trade with Options: Trading XHB All the Way Down with Puts

How to Swing Trade with Options: Trading XHB All the Way Down with Puts

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Here’s an inside look at the formula we used to predict the massive descent in XHB, looking for bearish trading opportunities through the entire plummet from $79.2 to its current low of $69.5 – a more than 12% drop in the stock from September 19th to October 25th. The key: long duration options, swing trading, and most importantly, technical analysis.

Swing Trading Options: Identifying the Trade in XHB

When we look for a swing trade opportunity, we scan across the entire market. That means some of the assets we target aren’t the first thing you think of when you consider making a trade. XHB is a great example of that. The XHB is a mid-sized ETF that represents the S&P 500 home builder stocks. From a macro basis, that’s a weak area due to soaring mortgage rates and buyer appetite cooling off. 

Source: Reuters

Currently, XHB’s largest holdings include Williams-Sonoma (WSM), Carlisle Companies (CSL), Trane Technologies (TT), and Lennox International (LII). At the time of writing, all four are trading below their 50 day moving averages – a sign that mortgages aren’t the only thing buyers are losing their appetites for. 

And take a look at this – here’s the XHB, the mothership of it all. Notice when the XHB started to break down below its 50 day moving average.

In August, a brief break lower – but the moving average was still pointing higher. Then, a reclaim of the 50D – which turned out to be a false breakout. Then, the XHB retested and failed to break back above the 50D moving average, and we saw the direction of the 50D begin to turn lower. Combined with macro news, this looked like a recipe for a technical breakdown in the stock – a disaster for bulls, but an opportunity for bears and technical options traders. 

On September 18th, we had seen enough. It was time to map out our trading plan. 

Forming a Trading Plan in XHB: Technical Analysis

First, we had to choose a contract. When deciding what contract will work best, we usually opt for slightly in-the-money options and plenty of time to expiration – but not so much time that we have to overpay for the option or mute the move of the stock. Options that are too far out in time can lack movement, liquidity, and they can be costly. On the other hand, options that are too near dated suffer from large amounts of theta decay and can be overly volatile. We like to select a happy medium. For this trade idea, we used two month out November monthly-expiring $79 strike put contracts.

Then, we started looking at technical levels in XHB.

Technical levels are how we trade momentum at Market Rebellion. Whether we’re trading a piece of UOA, or a breakdown/breakout in a stock, we’re always planning ahead. That means knowing where we’ll plan to enter (what we call a trigger level), and where we plan to take profit (by rolling an option down, and pocketing the difference). The ultimate goal is to cut emotion out of the picture, and make a plan that we can confidently stick to. 

Our first level (the trigger level – the one we use to determine when to enter) was easy – the August 25th low. We use recent lows as triggers and levels because we know that buyers had appetite at that level. If they don’t buy here this time, it can mean that the asset is about to go into a period of price discovery – meaning it could fall a reasonably large percentage from where it is at the time that it breaks lower. For XHB, that was the August 25th low point.

Notice how the stock bounces off this key level a few times following August 25th, and stops dead in its tracks on September 20th. Later, the stock attempts and fails to break back above this level, before continuing lower. That’s a great sign that we’ve chosen a solid level that the market really cares about. 

Of course, our work wasn’t done here. Picking an entry isn’t all we do – we also had to map out the exit doors, AKA our profit levels. Those, as we said above, are areas where we’ll look to roll for profit. 

For XHB, our first set of levels were $77.13, $76.26, $75.54. $64.03, $73.08, and $71.81 (200 day moving average). 

Those levels mapped out:

Some of these levels are previous areas of support and resistance. For instance, the $77.13 level worked as resistance 5 separate times through the month of June before breaking out, only to be retested successfully in July, where it turned into a level of support. The next level, $76.26, functioned the same way – a hard area of support throughout mid June, where XHB ping-ponged back and forth to form a tight trading channel. The next level was similar yet again, $75.54 was where, during the first week of June, we saw concentrated selling that put an end to the fast-paced rally that kicked off on June 1st. Other levels are moving averages – like the 200 day moving average, located at $71.81. $71.81’s 200D moving average also doubled as a level of support and resistance back in May, at the beginning of this chart.

With each new level attained, the goal is to scrape some money off the top of the trade. That said, you don’t have to do it every time – just when it makes sense to you from a profit perspective. For instance, when the stock fell sharply from $77.17 down to $75.54, you might have considered trading your $79 strike November put for a cheaper $76 strike November put. And when that descent continued lower to $71.81, you might have considered rolling that $76 strike put to a $72 strike put, once again pocketing the difference between the costs of the two options. 

As XHB continued to fall, our Rebel Pit traders continued to map out new areas of technical support and resistance – new levels to trade against. Additionally, they provided relevant pieces of UOA that they were seeing in the options flow data.

Those new levels were listed above, in the update log from Rebel Pit Essential. Those levels continue all the way down to $68.41 as of October 25th. However, had you simply chosen not to roll, got in when the alert was released with the stock at $79.2 and the option at $3.35, and then sold when the option when the stock hit its most recent level at $69.46, you would have sold the option for roughly $9.50 – nearly 3X what you paid for it. Otherwise, if you were rolling along the whole time, you may have made a bit less in total, but you would have traded in a safer manner, locking in profits as you went, and would today be trading only with “house money” – money that you made throughout the course of the trade.

Today, the stock is bouncing a bit off of our $69.46 level – however, with more than two weeks left to expiration, it’s anyone’s guess as to whether or not the Home Builder XHB ETF continues its descent – giving our Rebel Pit traders another opportunity to pull money from this piggy bank of a trade.

Want trade ideas like this every week, complete with technical analysis, specific entries and exits? Try a month of Rebel Pit Essential today.

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