An options trade that bets on consumer stocks rebounding — while hedging risk

CNBC

5 days ago

Seven months into the year, the total return for the S & P 500 is roughly 9%. The benchmark fell nearly 19% peak to trough into the post-liberation day lows, and has rallied 27% since. Given the U.S. economy's heavy reliance on consumer activity, which accounts for approximately 70% of gross domestic product, it's notable that the discretionary sector has significantly underperformed. Whereas the S & P 500 is trading at all-time highs, the consumer discretionary sector — which fell more than 26% peak-to-trough between Dec. 17 and April 8 — has yet to recover fully. It's more than 6% below its 2024 highs. Economic data has been pretty decent. Growth has exceeded expectations. Federal deficits, aided in part by tariff-related revenue, have been slightly lower than expected. Inflation, which hit levels not seen in the United States since the late 1970s in 2022, has also been moderating in the past several months. This has prompted many, the President most notably, to insist that the Fed should cut rates. Thankfully, the nation's central bank has thus far not bowed to pressure from the administration to do so. First, lower inflation — which we're grateful for — is not the same as deflation; that is, falling prices. Consequently, the cost of living remains a struggle for many as real wages declined between the second quarter of 2021 and mid-2023. Second, inflationary policy impacts remain. That's not from the Fed necessarily, which has maintained a relatively steady and predictable policy path and allowed its balance sheet to shrink, but from the Federal government, which continues on a fiscally unsustainable path. It's not just money printing and ZIRP (zero interest rate policy) that is inflationary; massive deficit spending is too. Third, even if the Fed cuts short-term rates, the cost of borrowing for durable goods and housing is driven by the longer end of the curve. Still, consumer and business sentiment have been improving, so I would expect consumer stocks to narrow their gap of underperformance relative to the S & P 500 - hopefully because they rally and not due to a fall in other sectors! One way to make a modestly bullish bet in the consumer sector is with a call spread risk reversal in Consumer Discretionary Select SPDR Fund (XLY). Purchasing an at the money call, partially financed through the sale of an 18 delta downside put and an 18 delta upside call. In the example I'm providing below, I've selected September "regular way" expiration. DISCLOSURES: None. All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL'S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.