Momentum Drives Consumer Discretionary ETF Higher

November 22^nd, 2021

Momentum Drives Consumer Discretionary ETF Higher

Dear Reader,

On Friday, we looked at a Daily Price Chart of Cintas Corp., noting that the stock’s 50-Day EMA is trading above the 100-Day EMA.

For today’s Trade of the Day e-letter we will be looking at a Moving Average Convergence/ Divergence (MACD) chart for the Consumer Discretionary Sector ETF symbol: XLY.

Before breaking down XLY’s MACD chart let’s first review the investment objective of the ETF.

The XLY ETF seeks investment results that correspond to the price and yield performance of publicly traded equity securities of companies in the Consumer Discretionary Select Sector Index. The index includes securities of companies from the following industries: retail; hotels, restaurants and leisure; textiles, apparel and luxury goods; household durables; automobiles; auto components; distributors; leisure products; and diversified consumer services.

MACD Indicator confirms Price Momentum

The XLY daily price chart below shows that XLY is in a price uptrend as the 24/52 day MACD line (black line) is above the 18-Day EMA (purple line). The Moving Average Convergence/ Divergence chart is shown below the daily price chart.

MACD uses moving averages to create a momentum indicator by subtracting the longer-term moving average from the shorter-term moving average. The MACD is calculated by subtracting a stock’s longer term 52-Day Exponential Moving Average (EMA) from its shorter term 24-Day EMA. This creates the MACD line.

MACD ‘Buy’ Signal

The 18-Day EMA line functions as a buy/sell ‘trigger’. When the 24/52 Day MACD line crosses above the 18-Day EMA line it indicates positive momentum and higher prices for the stock. When the 24/52 Day MACD lines crosses below the 18-Day EMA it indicates negative momentum and lower prices for the stock. MACD is more of a leading indicator than a moving average cross over which tends to lag price movement.

MACD Histogram shows Acceleration of Momentum

Also included in a MACD chart is the histogram bar graph. This portion of the chart helps to illustrate the distance between the 24/52 Day MACD and the 18-Day EMA.

When a crossover initially occurs, the histogram’s bar will be near flat as the two indicator lines have converged. As the lines begin to separate, the bars grow in height, indicating a widening gap and acceleration for the stock’s momentum. When the histogram’s bars begin to shrink this indicates a narrowing of the gap between the 24/52 Day MACD and the 18-Day EMA and a slowing of the stock’s momentum. When the gap between the two indicators begins to narrow, this typically indicates a crossover of the indicator lines could happen soon.

Buy the XLY ETF

As long as the 24/52 Day MACD line remains above the 18-Day EMA, the stock is more likely to keep trading at new highs in the coming days and weeks.

Since XLY’s bullish run is likely to continue, the ETF should be purchased.

Our initial price target for the XLY ETF is 230.00 per share.

91.7% Profit Potential for XLY Option

Now, since XLY’s 24/52 Day MACD is trading above the 18-Day EMA this means the stock’s bullish rally will likely continue. Let’s use the Hughes Optioneering calculator to look at the potential returns for a XLY call option purchase.

The Call Option Calculator will calculate the profit/loss potential for a call option trade based on the price change of the underlying stock/ETF at option expiration in this example from a flat XLY price to a 12.5% increase.

The Optioneering Team uses the 1% Rule to select an option strike price with a higher percentage of winning trades. In the following XLY option example, we used the 1% Rule to select the XLY option strike price but out of fairness to our paid option service subscribers we don’t list the strike price used in the profit/loss calculation.

Trade with Higher Accuracy

When you use the 1% Rule to select a XLY in-the-money option strike price, the XLY ETF only has to increase 1% for the option to breakeven and start profiting! Remember, if you purchase an at-the-money or out-of-the-money call option and the underlying stock/ETF closes flat at option expiration it will result in a 100% loss for your option trade! In this example, if the XLY ETF is flat at 211.42 at option expiration, it will only result in a 3.5% loss for the XLY option compared to a 100% loss for an at-the-money or out-of-the-money call option.

Using the 1% Rule to select an option strike price can result in a higher percentage of winning trades compared to at-the-money or out-of-the-money call options. This higher accuracy can give you the discipline needed to become a successful option trader and can help avoid 100% losses when trading options.

The goal of this example is to demonstrate the powerful profit potential available from trading options compared to stocks.

The prices and returns represented below were calculated based on the current ETF and option pricing for XLY on 11/19/2021 before commissions.

When you purchase a call option, there is no limit on the profit potential of the call if the underlying stock/ETF continues to move up in price.

For this specific call option, the calculator analysis below reveals if the XLY ETF increases 5.0% at option expiration to 221.99 (circled), the call option would make 44.1% before commission.

If the XLY ETF increases 10.0% at option expiration to 232.56 (circled), the call option would make 91.7% before commission and outperform the stock return more than 9 to 1.

The leverage provided by call options allows you to maximize potential returns on bullish stocks/ETF.

The Hughes Optioneering Team is here to help you identify winning trades just like this one.

Interested in accessing the Optioneering Calculators? Join one of Chuck's Trading Services for unlimited access! The Optioneering Team has option calculators for six different option strategies that allow you to calculate the profit potential for an option trade before you take the trade.

Trade High Priced Stocks for $350 With Less Risk

One of the big advantages to trading option spreads is that spreads allow you to trade high price stocks like Amazon, Google, Netflix or Apple for as little as $350. With an option spread you can control 100 shares of Google for $350. If you were to purchase 100 shares of Google at current prices it would cost about $273,000. With the stock purchase you are risking $273,000 but with a Google option spread that costs $350 your maximum risk is $350 so your dollar risk is lower with option spreads compared to stock purchases.

Get Chuck's Trades Sent to You!

Do you want to start receiving hand-picked trades from 10-Time Trading Champion, Chuck Hughes?

As a Trade of the Day subscriber, Chuck is offering you a special discount on his Weekly Option Alert Trading Service.

Just call Brad at 1-866-661-5664 or 1-310-647-5664 to join and use the code "Optioneering VIP" to receive special pricing!

Wishing You the Best in Investing Success,

Chuck Huges Signature

Chuck Hughes

Editor, Trade of the Day

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Momentum Drives Consumer Discretionary ETF Higher

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