Recently released data from the second quarter of 2017 suggests that the US economy is starting to expand at a slightly faster rate.
Clocking in at 2.7% , the US economy during the second quarter of 2017 expanded well beyond the first quarter rate of 1.2%.
While it's uncertain whether that rate of expansion will be maintained in future quarters, the fact that the first positive surprise was registered in quite some time is certainly worth noting.
A healthier economy could, in turn, cause the US Federal Reserve to reconsider their slow pace of raising interest rates. And one can bet this will be a big focus during the next meeting of this group in September 2017.
If you are bullish on the US economy and believe that the outlook is rosier after this second quarter data release, it may be worth taking a closer look at the financial sector for new opportunities in your volatility portfolio.
A healthy economy and a rising rate environment can often translate to good news for financial companies, which could, in turn, mean that implied volatility in this sector may be in for a drubbing. Traders with this outlook are left with a couple choices - namely getting long directionally in the financials, getting short premium in the financials, or a combination of both.
A recent episode of Options Jive zeroed in on the financial sector in particular and may be of interest to traders looking for opportunities in this space.
The purpose of the show was to introduce traders to the KRE, which is a regional banking sector ETF that has historically been highly correlated to the XLF - the well-known broader financials sector ETF.
On the show, the hosts point out how KRE trades at a higher price than XLF, but also with higher implied volatility. While the higher absolute implied volatility may be attributable to the fact that the companies within it overall possess smaller market capitalization than those in the XLF, that doesn’t mean the KRE isn’t a good fit for your portfolio.
The graphic below shows how closely correlated the KRE and XLF have been in recent months:
As you can see above, the correlation between these two underlyings is 0.9, which is very high. Things get even more intriguing when one considers the fact that KRE implied volatility is closer to 20, while XLF implied volatility is closer to 15.
While traders may want to apply other criteria to KRE before ultimately deciding whether to add this exposure to their portfolio, the idea is certainly worth additional consideration. Looking at the components of both ETFs is another good way of evaluating whether the product has the risk characteristics you are seeking.
We recommend reviewing the complete episode of Options Jive focusing on KRE and XLF when your schedule allows.
Another episode of Options Jive is also recommended for those viewers looking for ideas on how to match their outlook with the appropriate position structure.
As always, we hope you’ll reach out to email@example.com with any comments, questions, or suggestions.
Thanks for reading!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.