Even though the overall market continues to act very well, there are certain sectors of the market that I believe could be at risk of a pullback as we move thru earnings season. I already suggested buying hedges on the homebuilders on Friday (here), and that is a trade I continue to favor ahead of those earnings (especially now that 10-year yields moved above the 4.2% level on Friday). Another sector that I believe hedges should be considered in are the consumer staples (XLP). Here are just some of the reasons why I believe downside structures could pay off over the next month or so:
1. Staples just staged one of their most explosive rallies in the last few years
In a span of just over a week, the staples rallied by ~ 8% and went from the bottom-end of their well-defined 2-year range (~ 76) towards the top-end of their range (~ 83-84) in a matter of days. This rally has moved the group to just below the highs hit last June-August and perhaps used up any upside momentum they could have had on earnings (assuming they weren’t too bad).
XLP with an 8% rally in just over a week and has now moved from the low-end of the 2-year range to the high-end as we approach earnings for the sector
2. 10-year yields broke above key technical resistance of 4.2% on Friday
Staples tend to trade inversely to yields as they become a de-facto “yield” play when rates move lower. That is also likely a function of their “defensive” nature so that when yields are moving lower (perhaps on a risk-off trade) staples tend to be a decent hiding space to park money. Now that they have already rallied AND yields appear to be on the move higher again, perhaps we see some profit-taking or real selling in the sector on earnings?
Now that the 10-year yield is above the key 4.2% level, could we see staples (and other rate-sensitive areas of the market) come under some pressure?
3. The large short interest in the group likely contributed to some of the sharp rally
At the end of 2025, short interest in XLP was at a multi-year high and up 200% from the lows we saw in 2024. This offsides in positioning probably had a lot to do with the magnitude of the move we saw over the past week or so. Now that we have already seen the spike, and my guess is some of that shortinterest exposure has been covered, I think we could see a move back lower as the earnings/fundamentals take hold.
At 2025 year-end, the short interest in XLP had reached a multi-year high and was up 200% from ~ 19mm to over 57mm shares (bottom chart)
4. Walmart (WMT) being added to QQQ and Costco (COST) oversold rally both likely contributed to some of the push higher
The two largest weightings in XLP are WMT (11.6%) and COST (9.4%). WMT has been very strong and was officially added to the Nasdaq 100 (QQQ) as of the close on Friday (that also may explain the $3 rally in shares in the last half hour of trading). With the QQQ addition now behind us, perhaps with shares up 20% from the Nov lows AND stock now trading at a gaudy 45x (or over 12 turns higher than AMZN), we could be setting up for a decline/pullback? As far as Costco, shares declined by 20% from their June highs to the December lows (as most everything else rallied) and have rallied 13% just in the past 2 weeks. With both names having performed well of late (for different reasons), perhaps they too are setting up for a pullback over the next month? Walmart reports on 2/19, which is the day before Feb regular (2/20) options expire, and thus should keep a bid to XLP vol thru earnings in my opinion.
WMT shares up 20% from the November lows, likely helped by the addition to the Nasdaq 100 which happened on Friday
Costco shares have rebounded 13% in the past 2 weeks after declining by 20% from their June highs (as the market rallied higher)
If looking to either hedge the sector, or own limited-risk bearish structures, this is the trade I would consider at this time:
Buy XLP Feb 20th XLP 81 puts 1x
Sell XLP Feb 20th XLP 76 puts 2x
Costs ~ $0.45 – $0.50 (XLP Fri close ref price of 82.11)
The GREEN area shows where the Feb 1×2 put spread makes money at expiration
Trade Details:
- Buying the 1-month (Feb) 1×2 ratio put spread in the main consumer staples etf following very sharp rally to the upper-end of the 2-year range
- Large short interest, some risk-off trading from the crowded tech sector and positive moves/news from WMT and COST all likely contributed to the sharp rally
- Higher yields, somewhat stretched valuations and margin pressures should keep a lid to upside performance at these levels
- Prefer the 1×2 ratio trade as that; 1) captures very favorable put skew, 2) targets a move back to the support lows and 3) large short interest also should provide buying support on another decline
- Trade makes money between ~ $80.55 and $71.45 at Feb 20th expiration (-1.9% to -15%), with max profit at $76 (8% lower and at the 2-year support area)
- Put spread starts just over 1% lower, has a max payout of 9-10x to 1 and captures earnings for most of the top-weighted names
- Really like this structure as either a hedge or a low-cost/limited-risk bearish bet for a sector that continues to have sharp realized moves both higher and lower in a very well-defined range
- Please reach out to me or the 22V sales team for updated pricing and execution capabilities
