XLP is the Consumer Staples Sector ETF, consisting of companies that sell essential goods people buy regardless of the economy (e.g., food, beverages, and household products).
Investors tend to invest in these companies as a defensive play if they believe the economic outlook is not good.
Contents
- Bearish On XLP
- Bullish On XLY
- Three Weeks Later
- The Combined Trade
- Summary
XLY is the Consumer Discretionary Sector ETF, consisting of companies that sell non-essential goods and services, like luxury items, entertainment, and leisure.
In other words, these are things that people buy when the economy is good and when consumers have more disposable income during economic expansion.
Investors in a “risk on” mode will rotate funds out of Consumer Staples and into Consumer Discretionary.
Hence, this will drive the price of XLY higher faster than XLP.
If we look at the price ratio of XLP to XLY, we see it has been declining since May 2025, suggesting funds are being rotated out of XLP and into XLY.
A decreasing ratio means that XLY is appreciating faster than XLP.
Source: You can create this ratio graph by entering “XLP/XLY” into the ticker box of Tradingview.com.
This bullish sentiment is evident in risk-on investor behavior, as the market (SPY) continues to reach new highs.
Bearish On XLP
Let’s say that an investor notices this trend in June.
Because XLP is out of favor, the investor can apply a bear call spread on XLP:
Date: June 2, 2025
Price: XLP @ $82.27
Sell two contracts July 3 XLP $83 call @ $1.00
Buy two contracts July 3 XLP $85 call @ $0.15
Net credit: $170
The credit spread was placed near the money, so the maximum risk in the trade is $229, with a potential maximum profit of $170.
Bullish On XLY
At the same time, the investor applies a bull put credit spread on XLY, trying to structure it with the same risk and reward as the first trade.
Date: June 2, 2025
Price: XLY @ $82.27
Sell one contract July 3 XLY $210 put @ 4.18
Buy one contract July 3 XLY $205 put @ $2.18
Net Credit: $200
Three Weeks Later
After 21 days in the trade, on June 23rd, XLP had in fact gone down:
This move gave a profit of $156 on the bear call spread:
For Consumer Discretionary XLY, it moved sideways:
But it went up just enough to give a slight positive theta, resulting in a profit of $109 on the bull put spread:
The Combined Trade
For the combined trade, the net profit is $265 ($156 + $109).
The max combined total risk in both trades is $530 ($230+ $300).
That is about a 50% return on the capital at risk in three weeks.
Summary
Investors often compare XLY vs XLP as a gauge of consumer sentiment.
XLP represents what consumers need.
XLY represents what consumers want.
If you plot the ratio of XLP over XLY and see a trend in one direction or the other, that may suggest a rotation of funds from one to another.
Hence, the investor can structure a bearish trade on one while having a bullish trade on the other.
In our example, we were bearish on XLP and bullish on XLY.
But since XLY is more than twice as big as XLP, we had to use two contracts of XLP for every contract of XLY to size both trades to approximately the same size.
We hope you enjoyed this article on the XLP and XLY sector rotation trade strategy.
If you have any questions, please send an email or leave a comment below.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
Original source: https://optionstradingiq.com/xlp-and-xly-sector-rotation-strategy/