A bet that this monster rally is stalling out and this sector will start to suffer first

Published Tue, Dec 19 202310:31 AM EST

Nishant Pant @TheMeanTrader @TheMeanTrader

The broad monster rally which started in November has shown no signs of stalling yet, but it will eventually. Underneath the surface, you'll start to see money flowing out of certain sectors first. We'll present an options trade here to capitalize on that sector rotation, specifically how to bet against an industry likely to see outflows. In the chart below, I have pulled up Health Care Select Sector SPDR ETF (XLV) .Note that after a massive run up, XLV is getting rejected at resistance around $136 area. This is also an area where XLVwas rejected multiple times this year. Also note that RSI (relative strength index) has dropped below 70 after being overbought. This helps further strengthen my bearish bias on the health care sector. If the healthcare sector keeps pulling back, most of the stocks in this sector will also tend to pull back. One interesting stock I found is Vertex Pharmaceuticals (VRTX) . It hit a record just a few days ago after it's phase -2 study on their drug VX-548 which treats diabetic peripheral neuropathy showed promising results. However, after a more than 7% move in a single day, VRTX seems to be giving up some of its gains. I am going to construct an options trade called a "bear call spread" which bets on VRTX not going above $415 in the next 30 days. The Trade Setup: VRTX $415-$420 Bear Call Spread Based on the charts, I am betting that VRTX will not go above $415 in the next 30 days. (Vertex trading around $402 currently.) To do this, all I need to do is sell a $415 call option. This brings in a credit of approximately $600, and I will make money on this trade if VRTX expires below $415 on expiration date. However, my trading platform tells me that this will tie up $7,000 of margin to put on this trade. This is a lot of money for a mere $600 potential profit. To reduce the margin requirement, I can also buy a $420 call option at the same time, which costs me $445. By simply doing this, my margin requirement drops to a mere $345. Since I am paying a debit to buy the $420 call, it also reduces my profit potential to $155. The option chain on VRTX also tells me that the probability of VRTX expiring at $415 by expiration date is only 35%. That makes it a high probability trade which has a 64.46% chance of winning. Here is my exact trade setup: Sell $415 call, Jan. 19 expiry Buy $420 call, Jan. 19 expiry Cost: $3.45 Potential Profit: $1.55 Profit Target: If VRTX is trading below $415 on expiration date, I get to keep the full premium of $155 that this trade will bring in. Scaling up: Scaling up is as easy as adding more contracts. By adding 10 contracts, I have the potential of making $1550 by risking only $3450. Compare this to selling a $415 call option which was bringing in only $600 while tying up $7,000 in portfolio margin. Managing losses: This is a high probability trade which means I can expect 6 out 10 such trades to be winners. However, note that the losses are bigger than the profit. I will need a good trade management plan with a stop loss in case the trade starts going against me. -Nishant Pant Founder: https://tradingextremes.com Author: Mean Reversion Trading Youtube, Twitter: @TheMeanTrader DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL'S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.