Alert

LEARN HOW TO SET UP AND MANAGE A PORTFOLIO IN 4 EASY STEPS WITH DR. JIM SCHULTZ!

Another Angle on Trading Sector ETFs

Apr 18, 2017

By: Sage Anderson

A recent blog post highlighted an approach to trading the sector ETFs that may have been of interest to tastytraders. Today we are expanding on that topic...

Essentially, the ETF strategy outlined last time seeks to exploit relationships that exist between the SPY (which is an ETF composed of the S&P 500 components) and the sector ETFs, which are the 10 unique funds that divide up the SPY by business category, including: XLY, XLP, XLE, XLF, XLV, XLI, XLB, XLRE, XLK, and XLU.

In the previous post, we focused on the ETFs that showed a high correlation with SPY - meaning when SPY goes up, that particular ETF goes up to a similar degree. Such a relationship can open up opportunities for trading volatility or direction against the SPY.

A recent episode of Options Jive took this analysis of the sector ETFs a step further.

On this episode, the team instead focused on the sector ETFs with correlations to SPY that were at the lower end of the spectrum. This means that if the SPY moves up, the XLE (for example) might move up as well, but to a lesser degree than say XLI (which was one of the most highly correlated to SPY at that time).

What the Options Jive team decided to evaluate was not only the correlation of XLE to SPY (and the fact that it was on the lower end of the spectrum), but also the correlation of XLE implied volatility with SPY implied volatility. So not only the degree to which the two symbols moved together, but also the relationship between implied volatility of the two.

Basically, a high correlation of implied volatility would mean that when SPY implied volatility goes up, then the implied volatility of XLE (for example) goes up to a similar degree.

Such a relationship might indicate that when the spread between absolute implied volatility of SPY and XLE is at extremes (high or low compared to the average spread) there may be an opportunity to trade.

The graphic below shows the dynamic spread between the absolute implied volatility of SPY and XLE (the Energy ETF) over time. The yellow line represents the average spread between the two:

As you can see above, the spread between the absolute volatility of SPY and XLE got as high as roughly 15 points in January 2016 (which incidentally was when oil was experiencing a selloff). After oil stabilized, the spread between SPY and XLE implied volatility dropped significantly to almost zero, which was well below the historical average of roughly 9 points.

Depending on your approach and risk profile, it may be beneficial to look at the spread between implied volatility in SPY and the sector ETF you are considering for a trade. If the spread is on the higher end of the historical range, and you are a seller, it may give you even more confidence that this might be the appropriate course of action.

We recommend reviewing the complete episode of Options Jive when your schedule allows for the best possible understanding of this analysis.

If you have any questions about correlations between SPY and the sector ETFs we hope you'll reach out directly at support@tastytrade.com.

We look forward to hearing from you!


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.

© copyright 2013 – 2021 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.