Yesterday, we looked at a Monthly Price Chart of Walmart Inc. noting the stock’s 1-Month Price is trading above the 10-Month SMA signaling a ‘Buy’.
For today’s Trade of the Day we will be looking at a Keltner Channel chart for the iShares U.S. Home Construction ETF, symbol: ITB.
Before breaking down ITB’s daily Keltner Channel chart let’s first review the investment objective of the ETF.
The ITB ETF measures the performance of the home construction sector of the U.S. equity market, as defined by the index provider. The fund generally will invest at least 80% of its assets in the component securities of its underlying index and in investments that have economic characteristics that are substantially identical to the component securities of its underlying index.
Now, let’s begin to break down the Keltner Channel chart for ITB. Below is a Daily Price Chart and the three Keltner Channels for the ITB ETF.
Buy the ITB ETF
The Hughes Optioneering Team uses the Keltner Channels as an indicator to determine whether an ETF is overbought or oversold. If an ETF’s daily price is trading above the upper Keltner Channel, this signals that the ETF is temporarily overbought and subject to a retracement.
Even ETFs that are in the strongest bull trends do not advance in a straight line. There are always price retracements along the way. When an ETF becomes overbought, it’s price will typically decline soon after as the inevitable profit taking occurs.
The ITB daily price chart shows that the ETF is in a strong price uptrend and has become overbought several times. You can see this as ITB has traded above the Upper Keltner Channel on multiple occasions recently.
But, in every scenario when ITB became overbought, the ETF soon experienced a pullback.
Finding opportunities when an ETF experiences a pullback is why the Hughes Optioneering Team uses the Keltner Channels. They help us find a lower-risk entry point.
The Keltner Channel “Buy Zone” occurs when an ETF is trading below the upper Keltner Channel. Once the daily price is trading below the upper channel, it provides a lower-risk buying opportunity as the ETF is likely to rally.
Our initial price target for ITB is 86.50 per share.
98.0% Profit Potential for ITB Option
Now, since ITB is currently trading in the Keltner Channel ‘Buy Zone’, this offers a prime trade entry opportunity. Let’s use the Hughes Optioneering calculator to look at the potential returns for an ITB call option purchase.
The Call Option Calculator will calculate the profit/loss potential for a call option trade based on the price change of the underlying stock/ETF at option expiration in this example from a flat ITB price to a 12.5% increase.
The Optioneering Team uses the 1% Rule to select an option strike price with a higher percentage of winning trades. In the following ITB option example, we used the 1% Rule to select the ITB option strike price but out of fairness to our paid option service subscribers we don’t list the strike price used in the profit/loss calculation.
Trade with Higher Accuracy
When you use the 1% Rule to select an ITB in-the-money option strike price, ITB only has to increase 1% for the option to breakeven and start profiting! Remember, if you purchase an at-the-money or out-of-the-money call option and the underlying ETF closes flat at option expiration it will result in a 100% loss for your option trade! In this example, if ITB is flat at 81.76 at option expiration, it will only result in a 3.6% loss for the ITB option compared to a 100% loss for an at-the-money or out-of-the-money call option.
Using the 1% Rule to select an option strike price can result in a higher percentage of winning trades compared to at-the-money or out-of-the-money call options. This higher accuracy can give you the discipline needed to become a successful option trader and can help avoid 100% losses when trading options.
The goal of this example is to demonstrate the powerful profit potential available from trading options compared to ETFs.
The prices and returns represented below were calculated based on the current ETF and option pricing for ITB on 7/6/2023 before commissions.
When you purchase a call option, there is no limit on the profit potential of the call if the underlying ETF continues to move up in price.
For this specific call option, the calculator analysis below reveals if the ITB ETF increases 5.0% at option expiration to 85.85 (circled), the call option would make 47.2% before commission.
If the ITB ETF increases 10.0% at option expiration to 89.94 (circled), the call option would make 98.0% before commission and outperform the ETF return nearly 10 to 1*.
The leverage provided by call options allows you to maximize potential returns on bullish ETFs.
The Hughes Optioneering Team is here to help you identify profit opportunities just like this one.
Interested in accessing the Optioneering Calculators? Join one of Chuck’s Trading Services for unlimited access! The Optioneering Team has option calculators for six different option strategies that allow you to calculate the profit potential for an option trade before you take the trade.
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Wishing You the Best in Investing Success,
Editor, Trade of the Day
Have any questions? Email us at firstname.lastname@example.org
*Trading incurs risk and some people lose money trading.