May 11th, 2022
Yesterday, we looked at a Monthly Price Chart for Agilent Technologies, Inc. noting that the stock’s 1-Month Price is trading below the 10-Month SMA.
For today’s Trade of the Day e-letter we will be looking at a daily price chart for the iShares U.S. Home Construction ETF, symbol: ITB.
Before breaking down ITB’s daily chart let’s first review the investment objective of the ETF.
The ITB ETF generally invests at least 90% of its assets in securities of the underlying index and in depositary receipts representing securities of the underlying index. The underlying index measures the performance of the home construction sector of the U.S. equity market.
Now, let’s begin to break down the Daily Price chart for the ITB ETF.
Below is a Daily Price chart with the 50-Day EMA and 100-Day EMA for ITB.
50-Day EMA and 100-Day EMA ‘Sell’ Signal
The 50-Day Exponential Moving Average (EMA) and 100-Day EMA are moving average indicator lines that can provide buy and sell signals when used together. When the shorter-term 50-Day EMA crosses above or below the longer-term 100-Day EMA, this provides either a buy or sell signal depending on which direction the stock price is moving.
- 50-Day EMA line Above 100-Day EMA = Price Uptrend = Buy signal
- 50 Day EMA line Below 100-Day EMA = Price Downtrend = Sell signal
When the 50-Day EMA (blue line) crosses above the 100-Day EMA (red line) this indicates that the ETF’s buying pressure has begun to outweigh the selling pressure signaling a ‘buy’ signal. When the 50-Day EMA crosses below the 100-Day EMA this indicates that the selling pressure has begun to outweigh the buying pressure signaling a ‘sell’ signal.
As the chart shows, on February 9th, the ITB 50-Day EMA, crossed below the 100-Day EMA.
This crossover indicated the selling pressure for the ITB ETF exceeded the buying pressure. For this kind of crossover to occur, an ETF has to be in a strong bearish downtrend.
Now, as you can see, the 50-Day EMA is still below the 100-Day EMA meaning the ‘sell’ signal is still in play.
As long as the 50-Day EMA remains below the 100-Day EMA, the ETF is more likely to keep trading at new lows and bearish positions should be initiated.
Our initial price target for ITB is 52.75 per share.
82.4% Profit Potential for ITB Option
Now, since ITB’s 50-Day EMA is trading below the 100-Day EMA this means the stock’s bearish decline will likely continue. Let’s use the Hughes Optioneering calculator to look at the potential returns for an ITB put option purchase.
The Put Option Calculator will calculate the profit/loss potential for a put 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% decrease.
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 decrease 1% for the option to breakeven and start profiting! Remember, if you purchase an at-the-money or out-of-the-money put 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 57.33 at option expiration, it will only result in a 1.9% loss for the ITB option compared to a 100% loss for an at-the-money or out-of-the-money put 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 put 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 5/10/2022 before commissions.
When you purchase a put option, there is no limit on the profit potential of the put if the underlying ETF continues to move down in price.
For this specific put option, the calculator analysis below reveals if the ITB ETF decreases 5.0% at option expiration to 54.46 (circled), the put option would make 40.2% before commission.
If the ITB ETF decreases 10.0% at option expiration to 51.60 (circled), the put option would make 82.4% before commission and greatly outperform the ETF’s return.
The leverage provided by put options allows you to maximize potential returns on bearish ETFs.
The Hughes Optioneering Team is here to help you identify winning trades 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
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