An Option Play On Further Industrial Weakness

| About: Industrial Select (XLI)

When taking a look at a year-to-date chart of the S&P 500 (NYSEARCA:SPY) and the Dow Jones Industrial Average (NYSEARCA:DIA) both of these indexes have fallen below where they started at the beginning of the year. If investors feel there is more downside to continue then taking a look at trading some of the major ETFs that are correlated to a particular sector can be profitable if the market will be seeing more downside in the short term.

One ETF that I am taking a look at making a bearish options play on is the Industrial Select Sector SPDR (NYSEARCA:XLI). The XLI is made up of industrial companies that seek to represent the industrial sector of the S&P 500 and is made up of stocks in aerospace and defense, industrial conglomerates, rail and commercial companies. The XLIs top 10 holdings can be seen below:

Top 10 Holdings (49.49% of Total Assets)
Company Symbol % Assets
General Electric Company Common GE 10.98
United Technologies Corporation UTX 5.53
United Parcel Service, Inc. Com UPS 5.46
Caterpillar, Inc. Common Stock CAT 5.08
3M Company Common Stock MMM 4.56
Boeing Company (The) Common Sto BA 4.28
Union Pacific Corporation Commo UNP 4.20
Honeywell International Inc. Co HON 3.55
Cummins Inc. Common Stock CMI 2.93
Emerson Electric Company Common EMR 2.92

When the markets are bullish the industrial sector is one sector that usually rallies, but lately this sector can be seen as broken down and there could be more downside to go. The recent disappointing jobs number and further European worries are two concerns that are dragging down industrials. When taking a look at a two-year chart of the XLI, investors will notice this isn't the first time the XLI has made large moves upward only to follow back down/below where the XLI started off at.

Chart forIndustrial Select Sector SPDR

When looking at the chart above the $38 level can be seen as solid resistance over the last two years and currently if the downtrend in industrials continues to follow as the markets gets more bearish, then the $32 level could be the next level that the XLI tests before making a sustained move to the upside. If the $32 level doesn't hold then I would expect the XLI to test the $30 level.

Within the top 10 holdings Caterpillar (NYSE:CAT) and Boeing (NYSE:BA) are currently the two worst performers in the XLI. When taking a look at the rest of the top 10 holdings they have all seen significant pullbacks and are below or near where they started at on a year-to-date basis. The recent pullback has provided some opportunities to consider buying industrial related stocks and some of the stocks within the XLI have attractive dividend yields for long-term investors. In the short term if investors feel that further disappointing economic data will drive the market lower, industrials is one sector that is sure to follow the market trend downward. Here is a bearish option play that can be profitable if the XLI moves further downward:

Trade: Buy July 33/30 Vertical Put Spread

Buy (1) July 33 XLI put = 1.25

Sell (1) July 30 XLI put = 0.42

Total Cost For Trade = $0.83 (0.83 x 100 = $83)

Max Profit = (33 - 30 = 3) ( 3 - 0.83 = 2.17 or 2.17 x 100 = $217 per 1:1 spread)

Days Till Expiration = 46

In conclusion, the top 10 holdings that are listed in the XLI are great companies, but due to their international exposure and poor U.S. economic data the XLI could see further weakness for the summer. Rather than trying to pick out individual names and making bearish option plays on them this trade above is a risk-defined trade that plays on further weakness in the sector. Also, market sentiment appears to be weak in industrial names in general and it appears that a bottom may be close, but I wouldn't be surprised if further disappointing economic news coming out of Europe in the next couple of weeks helps add to the bearish sentiment. In the trade mentioned above if investors agree that more downside will be coming, I would wait until there is some sort of rally in the markets and then put on this trade as a rally could just be a head fake.

Disclosure: No positions. I will be considering a bearish put spread in the XLI.

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