Three Hot Sectors to Watch Right Now

Looking beyond the market averages and focusing on specific sectors can help find interesting trends. After all, the Dow Jones Industrial Average and the S&P 500 haven't been doing much lately. The average daily move in the S&P over the past 20 days is only 3.7 points. For directional traders, the lack of movement and volatility can be frustrating because it becomes a lot harder to make money when the market is trading sideways in a narrow range. But by compartmentalizing the market into sectors, it's possible to find areas exhibiting vertical movement and volatility. As Jim Cramer is fond of saying, "There's always a bull market somewhere." With that in mind, here are three hot sectors to watch right now.

There is a frenzy going on in the rare-earth stocks. The action picked up noticeably last week after China cut export quotas on rare-earth materials. Rare Element Resources ( REE) is up 60.9% since Dec. 23. During that time, Molycorp ( MCP) has rallied 34.5%, China Shen Zhou ( SHZ) surged 146.5%, and Avalon Rare Metals ( AVL) gained 65.1%. The rare-earth sector is moving!

The relatively new Market Vectors Rare Earth Strategic Metals ETF ( REMX) is a way to play the trend. The fund holds the aforementioned MCP, AVL and REE, but also a basket of other names from across the globe (click here for full list). Shares are up 15% since Dec. 23, and REMX options are beginning to catch the interest of traders as well. Vertical spreads in February or May calls might make sense for those investors looking for upside exposure to the red-hot rare-earth stocks.

Coal stocks have also been smoking! Arch Coal ( ACI), for example, is up 45% since reporting earnings on Oct. 29. Shares notched a new 52-week high Monday on reports that flooding in Australia is taking a toll on coal supplies. Other names such as Massey Energy ( MEE), Patriot Coal ( PCX) and Peabody ( BTU) delivered solid returns during the final few months of 2010 as well.

Market Vectors Coal Fund ( KOL) is an interesting tool for playing the coal stocks. The exchange-traded fund holds ACI, PCX, BTU and 35 other names from the industry (click here for a complete list). Shares gained 26.3% in the fourth quarter of 2010 and are up 4.5% already in 2011. Players looking to play the coal sector and its powerful upward momentum might want to consider some bullish vertical spreads in the February or April contracts. Or, buying straddles and strangles in KOL might make sense if you expect volatility in the sector to pick up in 2011.

Media and technology names will be in focus this week and into the highly anticipated Consumer Electronics Association International Consumer Electronics Show (CES). Last year, ESPN unveiled its three-dimensional channel at CES and is expected to announce that it will start 24/7 programming in 3-D at the show this year. The venue has become a popular place for announcing new products and ideas. This year should be no exception.

Unfortunately, there are no direct plays on consumer electronics and CES. The Select Sector Technology Fund ( XLK), which holds all of the information technology names from the S&P 500, might be one option. Many large-cap tech names, including Microsoft ( MSFT) are presenting at the show. However, many of the key players in the industry are not tech companies, but more closely tied to the consumer products industry. They are media companies.

Disney ( DIS) is an idea. While it is an individual media company, Disney is also well diversified and has exposure to movies, radio and television. It is well positioned to benefit from trends in both media and technology. Annual revenue from all operations is a massive $38 billion. Disney is also a component of the Dow and is a core holding for many fund companies. In fact, institutions currently hold 68.7% of all Disney shares.

The stock is breaking out ahead of CES. Shares are up $0.80 to $39.79 today and more than rallied more than 6% during the past three days. Options are very actively traded. 19,000 calls and 19,000 puts traded through midday Wednesday. 41,000 calls and 18,000 puts traded yesterday, including morning buyers of January 38 call options at $0.86 each. After today's jump, these calls are $1.79 in-the-money and now worth almost $2. January 40 calls, which currently trade at $0.55, are today's most actives. These options will pay off if Disney shares rally through the CES conference and move beyond $40.55 by the January expiration in 16 days.

At the time of publication, Fred Ruffy had no positions in the securities mentioned.

Frederic Ruffy is an experienced trader and provides daily commentary and analysis of the options market. He is co-founder of the web site, WhatsTrading.com. His work has also appeared in Futures Magazine, Technical Analysis of Stocks & Commodities, Stock Futures and Options, and Sentiment.

In addition to writing market commentary and trading-related books and articles, Fred has also worked as an instructor, educating investors on advanced topics like measuring volatility, the benefits of sector rotation and the risks and potential profits from trading around earnings. An active trader himself, with over 15 years securities industry experience, his market observations and analysis of the options market are featured regularly in the financial press including Barron's, Reuters, The Wall Street Journal, and Bloomberg.

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