Smart Ways to Play a Range-Bound Technology ETF

Over the course of the first 25 trading days in 2015, the S&P 500 was caught in choppy trading. The index seemed to be extremely volatile, but in reality, every daily close was between 1,992.67 and 2,063.15. The midpoint between these two levels is 2,027.91. Measured against the midpoint, we are talking about a 3.5% range. It sure seemed like the market moved a lot more than that, but every daily close was within 1.75% of the midpoint of the range.
The S&P did manage to move out of its range earlier this week, but I went looking for other indices or sector ETFs that might have been or are still in a range. That search led me to the Technology Select Sector SPDR (NYSE: XLK). The XLK actually went into its range in late October and interestingly the bottom side of the range was created when the ETF gapped higher on Oct. 31.
XLK Wyatt
We see the upper rail of the range is up at $42.40 and the lower rail is down at the $39.60 range. This puts the midpoint of the range at $41. Based on the midpoint, the range we are looking at is 6.83%.
Another thing that stands out on the chart is the fact that the daily stochastic readings are in overbought territory and the 10-day RSI is extremely close to overbought. In fact, the stochastic readings are the highest they have been since mid-November.
The play here looks to be for the XLK to move back down and the upper rail of the range to hold as resistance. However, should it break above the upper rail, it could move sharply higher.
There are a couple of ways that you could play this. Because the range is only 6.83%, I would use options to trade the XLK. If you want to be aggressive, you could buy puts and just play the downside of the move, because it’s at the top of the range and it is overbought. If you were to do this, I would set a mental stop to get out of the options should the stock move up to $43.
The other possibility is to play a straddle on the XLK by buying both the puts and calls at the $42.50 strike. Should you make this trade, you are counting on the XLK making a big enough move that the gain on the winning side will be big enough to offset the loss on the losing side. If the stock breaks out, the calls make a big jump. If the stock returns back down to the bottom of the range, the puts make money.
The key to this type of trade being successful is the move in the underlying ETF has to be substantial enough that one side of the trade makes enough money to offset the loss on the other side. It is a little more conservative than the straight put purchase, but the risk is that the price stagnates in the current range and both the puts and calls lose their time value.

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