Interest rates have been a hot topic of conversation lately and JC Parets from All Star Charts thinks rates are going higher thanks to the relationship between Regional Banks and REITS.
JC posted the following chart today showing the SPDR KBW Regional Banking (ETF) (NYSEARCA:KRE) vs the Real Estate Investment Trust REIT iShares Dow Jones US Real Estate (ETF) (NYSEARCA:IYR).
It doesn’t take a genius to spot the bull flag in this chart and if we do see a breakout that could be a boon for regional banks.
Remember that regional banks will perform well when interest rates are higher on the assumption that they will be able to make a higher spread between mortgage rates and deposit rates.
If traders think interest rates are going higher, they could trade SPDR KBW Regional Banking (ETF) (NYSEARCA:KRE) to the long side via a Bull Put Spread.
Traders willing to bet that the stock will stay above $57, could use the $57 strike as the short put and the $55 strike as the long put.
During Tuesday’s session, this trade offered a roughly 59% return on risk over the next 45 calendar days when using the April 21st expiry.
The maximum profit on the trade would be $74 per contract with a maximum risk of $126. The spread would achieve the maximum 59% profit if SPDR KBW Regional Banking (ETF) (NYSEARCA:KRE) closes above $57 on April 21st in which case the entire spread would expire worthless allowing the premium seller to keep the $74 option premium.
The maximum loss would occur if KRE closes below $55 on April 21st which would see the premium seller lose $126 on the trade.
The breakeven point for the Bull Put Spread is $56.26 which is calculated as $57 less the $0.74 option premium per contract. Keep in mind that due to the bid-ask spread, you may not be able to get filled at these prices.
The trade is not without its risks, with SPDR KBW Regional Banking (ETF) (NYSEARCA:KRE) looking a little overbought on a daily timeframe, but for traders thinking rising interest rates will see a flow on benefit to regional banks, this trade provides a nice potential return.
Disclosure: I currently have positions in IYR.
About the author: Gavin has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. He likes to focus on short volatility strategies. Gavin has written 5 books on options trading, 3 of which were bestsellers. You can read more from Gavin at Options Trading IQ.