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How to trade a breakout in transports stocks

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How to trade a breakout in the transports

Transports were in the red Wednesday ahead of a busy stretch for the group.

CSX is set to report earnings after the bell Wednesday and American Airlines, Southwest and Union Pacific are set for Thursday.

Todd Gordon, founder of TradingAnalysis.com, is betting on a breakout for this slice of the industrials sector.

"I've had my eye on this one for a while. We've been in a long consolidation, starting to move higher here. We're seeing sort of sub-industries within the transports like road and rails, air freight, logistics respond well here," Gordon told CNBC's "Trading Nation" on Tuesday. "Perhaps we'll start to see a little bit of a rotation out into the transports here again as the economy comes back online."

Gordon noted that the IYT transports ETF entered a stretch of consolidation from 2017 through to the beginning of this year. The beginning of the pandemic late in the winter sparked a major sell-off in the ETF, sending it to lows not seen in four years. However, since then, it has bounced nearly 80% off the March bottom.  

"We saw that big drop, and then we're coming back, finally wondering if this is the time that we're going to finally break through here," Gordon said. "When a market tries to get through a certain level, either upside or downside, four and five times, whoever is behind that, obviously the bulls on the upside and the bears on the downside, whoever is behind that fourth and fifth attempt really wants to get it."

"Here's an interesting way to play it, something I like to do when you're trying to get out of a range, which is called a diagonal. Traditionally what we do is we buy a call, sell a call up around our objective in the same month. What I'm thinking here, there might be some hesitation into the end of the year with the election, what I like to do is buy a longer-dated call, but sell something closer to us — selling a near-dated call," he said.

This diagonal spread is a bullish strategy — the short-dated call once it expires is then replaced with a longer-dated call. Gordon is buying the 210 call with March 19 expiration and selling the 225 call with Nov. 20 expiration.

"As you move into October and November, and if that value [on the short-dated call] is down, we can buy that call back and then what you do is you sell the same call and you go up to 230 in the regular March against the one you're long so then you have a regular March 210-230 call spread," he said. "You're trying to catch a little bit of decay in anticipation of maybe a hesitation breakout, the fade is working towards you on that short call and then just simply make it a call vertical in March."

The IYT ETF was down nearly 1% on Wednesday, but 20% higher over the past three months.

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