XLV: Another Breakout Attempt On The Cards Shortly

Intro

We wrote about Health Care Select Sector SPDR Fund (NYSEARCA:XLV) back in October of this year when we recommended a Jade Lizard options strategy. This strategy constitutes the sale of an out-of-the-money put option along with the sale of a corresponding out-of-the-money call spread. The reason we put on the strategy at the time was two-fold. One was the high levels of implied volatility in the underlying, and the second was the significant put skew evident in the stock at the time.

The benefit of this strategy is that it eliminates risk to the upside if it is put on properly. Furthermore, the high implied volatility at the time in XLV resulted in a high POP trade (Probability of Profit) where the odds were stacked in our favor. In the end, XLV continued its rally over the past 3 months or so, which enabled us to take off the position for a profit.

From a trader’s perspective, trading conditions have very much changed over the past 3 months or so. When we traded XLV back in October, its implied volatility was up around the 25% level. Currently, however, IV has dropped back down to the 16.5% level, which means our trading strategies (concerning options) become more limited for the following reason.

When IV is very low compared to itself over the previous 52-week period, selling option premium is literally not an option. One must turn to strategies that entail the purchase of options, which invariably means we are dealing with lower POP (Profitability of Profit) strategies. Furthermore, many times, these strategies result in the trader having to become directional in his or her position, which is always difficult even at the best of times.

Suffice it to say, there is a time to be directional when using options, and that time may be fast approaching in XLV. Therefore, let’s go through where we may buy this fund and our associated reasons for our bullish stance at present.

Technicals

If we first pull up an intermediate chart of XLV, we see that shares tried to punch out above their 2022 highs but could not manage it in this instance. Don’t let that fool you; however, another breakout attempt is not on the cards any time soon. The reason being is that the move out of the October lows was very aggressive and has actually resulted in a meaningful up-move in the ADX trend indicator (illustrating that shares have begun to trade). This bodes well for another breakout attempt to make itself known sometime soon, which we would buy if it can take place on strong volume.

Furthermore, as mentioned, that aggressive up-move over the past three months or so has resulted in a very strong RSI momentum reading which actually comes in higher than the fund’s previous peak back in April of this year. This along with the pattern of higher lows this year leads us to believe that XLV’s present pattern is more bullish in nature than anything else.

Flight To Quality

We see solid growth in action in XLV through metrics such as the fund’s assets under management as well as its long-term momentum stats. Over the past month, for example, AUM actually grew in XLV whereas the average ETF when calculating inflows over outflows actually experienced outflows (-2.3%). Furthermore, if we look at the fund’s long-term momentum, we see its three-year (32%) and five-year (63%) growth stats considerably outperforming the average ETF in these timeframes. Suffice it to say, as no technical damage has been done to the long-term charts, this momentum is more likely to continue than turn around any time soon.

In saying this, it is understandable that recession fears and rising inflation makes it difficult for investors to buy at market highs. However, an ETF such as XLV is very much immune to these trends, as we have seen throughout history when the fund has acted as a flight to quality due to its prioritization of value over growth.

Conclusion

Therefore, to sum up, due to XLV’s rising asset flows, bullish technicals, and the fact that the fund has performed well in times of historic high inflation, another breakout attempt could very well be on the cards very shortly here. We look forward to continued coverage.