from the desk of Dr. Terry F Allen

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Watch for the Bear Trap

Zurich-based Chubb Limited (CB) is the world’s largest publicly traded property and casualty insurance company. CB reported earnings this week that topped estimates. But the market wasn’t sure how to react, as analysts offered a mix of target price increases and decreases.  What’s clear, however, is that analysts are overwhelmingly bullish toward CB, as 84% give the stock a buy or better rating. Perhaps this is due to the “conventional” wisdom that insurance companies benefit from rising interest rates.

But analysts would be well advised to check out CB’s chart. Despite the solid earnings numbers, the stock ended the week flat. Moreover, it failed to break out of a four-month downtrend that has seen the stock drop 14%. This slide has been guided by the 20-day moving average (blue line in chart), which hasn’t allowed a daily close above it since early June. Above that lies the 50-day moving average (red line), which has yet to be tested. It sits at the $196 level, just a point above the short strike of our call credit spread. At its current slope, it will fall below this strike in the coming week. Thus, the stock will have to pierce two points of resistance to move into the money.

If you agree that the 20-day moving average will continue guiding CB lower, consider the following trade that relies on the stock staying below $195 (green line) through expiration in seven weeks:

Buy to Open the CB 16Sep 200 call (CB220916C200)
Sell to Open the CB 16Sep 195 call (CB220916C195) for a credit of $1.40 (selling a vertical)

This credit is $0.02 less than the mid-point price of the spread at Friday’s $188.64 close. Unless CB drops quickly, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $138.70. This trade reduces your buying power by $500, making your net investment $361.30 per spread ($500 – $138.70). If CB closes below $195 on September 16, both options will expire worthless and your return on the spread would be 38% ($138.70/$361.30).  

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