By Jay Soloff
With all the headlines about tariffs and interest rates these days, it makes sense to see a lot of trading activity going on in related sectors. That is, interest rates directly impact the financial sector; tariffs are a big deal for the basic materials and industrial sectors, etc.
One sector we haven’t heard as much about is health care. That’s not to say health care is being ignored – in fact, as we get closer to the 2020 election, it will likely be the most talked-about sector. But lately, it’s taken a backseat to more topical industries.
That being said, it came of something of a surprise to me to come across a massive trade in Healthcare Select Sector SPDR ETF(XLV). XLV is one of the 10 S&P 500 sector ETFs, so it definitely trades frequently. However, the options activity averages about 21,000 contracts per day – and this trade alone involved 200,000 options!
More specifically, a very large trader/fund purchased 100,000 of the October 25th XLV 91-92 call spreads for about $0.26. This was done with XLV’s share price at $88.79. The 91 strike was purchased, and the 92 strike was sold (100,000 contracts each). That means the max gain is at $92, which works out to $0.74 per contract in profits.
Doing the math, the trader can make $7.4 million at max gain. However, if XLV finished below $91, the spread expires worthless, and the $0.26 paid in premium is lost. That amounts to $2.6 million in losses. Breakeven occurs at $91.26. XLV would have to move up 2.8% in just over two weeks in order for this trade to reach the breakeven point.
Now, 2.8% may not seem like much of a move, but these sector ETFs don’t tend to be all that volatile. Still, a lot can happen in two weeks in October, as we’ve seen many times in the past.
So, what’s the motivation behind this huge, very bullish trade?
Is it based on something political? Perhaps this a bet that Biden is going to gain in the polls versus Warren. Biden is not advocating for “Medicare for All” like Warren, so that could be considered bullish for healthcare companies. Maybe it’s even a bet that Hillary Clinton is going to jump into the presidential race (as she’s also not expected to push for as big of a disruption to the healthcare sector as Warren).
That’s probably a longshot, though, because who knows how the winds may blow when it comes to politics. More likely, this trade is related to upcoming earnings in healthcare stocks.
Doing some research on XLV, it turns out that of the 61 stock holdings that make up the portfolio, 51% of the index is made up of the top 10 largest stocks. In fact, Johnson & Johnson(JNJ) alone makes up nearly 11% of the entire index.
Not only does JNJ report earnings prior to October 25th expiration, but so do two other companies in the top ten. That amounts to almost 25% of the index between those three stocks. This huge call spread is probably a bet that some or all of these earnings are going to beat expectations (particularly JNJ).
If this sort of strategy interests you (and you are bullish on health care), you could easily make a trade like this in your own account. At $0.26, you aren’t spending a whole lot to make this bet (unless you buy 100,000x of the spreads). What’s more, if XLV goes to $92, you’ll earn a 185% return on the trade.
This post was sponsored by Tim Plaehn, expert on income investing and a friend & colleague of mine at Investors Alley as well as a contributor here on SeekingAlpha. Tim runs the Dividend Hunter newsletter which offers a solid & diverse selection of attractive high yield plays. The service now has 9,000 active subscribers and can be had HERE for the rock bottom price of $49 (It usually is $99) for the first year. There are few better bargains around for those looking for solid income plays to balance their high beta holdings especially when equities get volatile!