Deconstructing the XLB

This is the final of 3 ETF studies this week. I included the XLB for a number of reasons that make it an attractive trading vehicle. Primary is the increase in volume and options open interest liquidity over the past year. The XLB currently averages 12M shares a daily and although the open interest is dwarfed by titans such as the Qs and XLF, there is good liquidity. One significant drawback of the XLB options for short term traders is the typical .10 - .15 Bid/Ask spread. As a result, limit orders are always advised, trying to hit the midpoint. If your platform has a built-in Black-Scholes calculator, you can figure the fair value and use as a limit value.
For XLB intraday trades the 8 minute bar parabolic SAR and 20 MA provide good triggers, and like many of the higher volume ETF's it responds well to the pivots.

The XLB is unique in that 10 companies make up 70% of the net assets. There are some interesting longer term correlated pair trades that can be set up using the XLB components and I'll look at a few of these in later posts.

The XLB put/call distrinution looks completely different that the Qs or the XLF, as the puts outnumber the calls by over 5:1. With the XLB's currently at 42.77 and the bulk of puts at the 38-41 strikes my suspicion is that these are largely short put positions looking to pick up premium decay. At the same time, the lack of open interest in the forward strikes indicates little short term optimism of the sector.

Finally, the short interest chart . . . and frankly, this is a bit of a surprise. The XLB's pay a dividend - currently .81, so if you're short through ex-div then you pay for it. I thought maybe the high short interest might be the result of some long call/short stock strategies, but the thin call open interest suggests otherwise. Also note that the short interest chart goes back to 2003, when the XLB was at 18 and trading 350,000 shares a day. Maybe there's just a lot of suspicion about the sector, but basic materials have a unique feature . . . they are finite and, like waterfront property, are limited resources. No need to get into a discussion of supply side economics or micro versus macro economics here. . . suffice to say the world's population is growing and everybody wants more stuff. It's the perception that counts.

The last 3 charts were sourced through http://www.schaeffersresearch.com/streetools/indicators/equity_oi_config.aspx

The posts this week on the XLF, Qs and XLB are, of course, just my subjective opinions and interpretations of the historical data. The intent of the blog is simply to stimulate dialogue and original thinking on the part of the readers and to help them develop their own perspectives and tactics for prospering in a trading environment.

Comments and alternate explanations of the charts and data are always welcome.