Collaring XLF …
You can see on the chart below that XLF has been slowly grinding higher in 2021, kicking off the year by taking out its pre-pandemic peak in the $30 neighborhood.
However, the fund took a breather in mid-March, pulling back from record highs above $35 to test support around $33.
The ETF’s subsequent rebound briefly stalled on the Archegos hedge-fund drama, but the shares this week managed to claw their way back to that familiar ceiling at $35.
Daily chart of XLF – courtesy of StockCharts
Against this backdrop, fear of a “double top” could be the reason we saw a relatively unique institutional hedge put on earlier this week.
Specifically, it looks like we spotted a rare “slingshot collar” in the Wall Street wilds.
A typical collar strategy consists of a protective put and a covered call option, used simultaneously to “insure” long shares of the underlying.
As with most hedges, the goal of a protective put isn’t for the underlying stock to fall off a cliff — it’s to limit losses in a worst-case scenario.
So while a “vanilla” put buyer is hoping the underlying stock falls beneath the put strike, the protective put buyer doesn’t want the option to move into the money (ITM), because that’d mean his or her shares are getting beat up.
The protective put buyer still wants the stock to move higher — the option is simply there to guarantee an acceptable “exit price” (the strike) for the shares, should they tank before expiration.
Meanwhile, the other half of a standard “collar” strategy is a covered call — an out-of-the-money (OTM) call option that’s sold to open against already-owned shares.
As part of the collar, the covered call is essentially there to help fund the protective put, as the seller can retain the initial net credit as long as the underlying shares stay beneath the call strike.
So in a best-case scenario with a standard collar, the underlying stock would move modestly higher — but not above the covered call strike, as the shares could get called away, leaving the trader to watch the rest of the rally from the sidelines.
Because the XLF institutional trader didn’t want to miss out on more upside, should XLF enjoy a big pop higher in the near term, they added a “slingshot” twist to the collar strategy.
… With a Twist
The hedge started as a normal collar. To protect their shares on the downside, they bought 50,000 29-strike puts expiring May 21 — this locks in a $29 exit price, in case XLF tanks below that level in the near term.
Then, instead of selling covered calls on the upside, they opened 100,000 bear call spreads at the overhead May 37/39 strikes.
In this situation, the trader can retain the net credit from the spread as long as XLF stays below $37 (the sold call strike) — a level that still represents uncharted territory for the ETF.
In fact, that credit is relatively substantial — the $0.16 per-spread credit more than covers the $0.07 cost to buy the OTM protective puts, not to mention twice as many bear call spreads were opened than puts purchased.
P/L of an XLF slingshot collar
Meanwhile, if the ETF lingers between the two call strikes, the underlying shares could get called away — similar to a standard collar strategy. That’s because the sold 37-strike call would be ITM, while the bought 39-strike call would still be OTM …
BUT, if XLF skyrockets above $39 before May 21, the bought 39-strike call would ALSO move into the money, and the institutional trader could then get those shares back by exercising the options!
In closing, it looks like the institutional trader is leaning bullishly toward the financial fund, but not enough to simply buy and hold XLF shares outright.
As such, they took steps to limit risk on a nosedive (via protective puts), and even MAKE some extra money if XLF stagnates below $37 (via the bear call spreads). Plus, they’ve eliminated the risk of sitting out a massive rally north of $39, as the bought half of the call spread gives them the right to buy the shares back at that price before expiration.
All in all, it’s a creative hedging strategy for nervous shareholders, and I’ll be interested to see how this one plays out.
(In the meantime, I’ll be attempting to stay RED HOT in my Sharp B.E.T.S. service — if you aren’t in that one, boy are you missing out!)
Your Only Option,