October 21, 2013 - A Safe Way to Enter the Mobile Sector
The importance of mobile technology in our day-to-day lives cannot be overstated. With mobile technology so engrained in our lives, it is easy to understand why so much attention is placed on stocks in the sector, and Wall Street will pay close attention this week as a string of mobile technology companies post earnings numbers for their most recent quarter.
A few of the companies tied to mobile technology that are scheduled to report their quarterly numbers include ARM Holdings (ARMH), Broadcom (BRCM) and AT&T (T), and their results will be used as a gauge of the overall sector.
Mobile technology's reach continues to spread and because it continues to grow in importance, the future is bright for the industry as a whole. However, it can also be a volatile sector. By its nature, technology is constantly changing, and companies can come in and out of favor with customers and Wall Street at an alarming rate.
To illustrate this point, we just need to look back at the last five years for smartphone maker Blackberry (BBRY). When the smartphone revolution first began, Blackberry was the dominant company. However, since Apple (AAPL) changed the market with its highly popular iPhone and a large number of Google (GOOG) powered Android phones came to market, Blackberry has fallen from grace. It went from the market leader to a company that controls less than 3% of the U.S. market.
I believe that the future is bright for mobile technology stocks, but investors do need to be aware of the inherent risks associated with stocks in the sector. Mobile technology continues to grow, but the smartphone market has matured and analysts fear of slowing sales in the years ahead. Technology changes and today's winners could easily turn into tomorrow's losers. A global economic slowdown could put the brakes on consumer spending. These are just a few examples of potential problems, but there are many more ways that mobile technology stocks could run into trouble.
With my bullish view on the sector, I want to put some money to work in mobile technology stocks, but I see enough potential pitfalls to look for a safer way to play the sector than just hand picking one or two stocks in the industry. This is why I prefer to play the exchange-traded fund Technology Select Sector SPDR (XLK). The ETF is not exclusive to mobile technology stocks, but they represent a big enough position to classify it as a mobile technology investment.
A quick scan over the top holdings in XLK shows a rather large portion of the holdings being either directly or indirectly related to mobile technology. Five of its top six holdings are Apple, Microsoft (MSFT), Google, AT&T and Verizon (VZ). The sole stock in the top six that does not have ties to the mobile market is International Business Machines (IBM).
The five stocks mentioned above combine to represent 41% of XLK's total holdings, and they are far from being the only mobile related stocks in the fund. You can also find Intel (INTC), Qualcomm (QCOM), Hewlett-Packard (HPQ)and the list goes on and on.
Each of these companies is in some way related to the mobile sector, and as time goes on I expect mobile will become an even greater percentage of their overall business models.
Because XLK contains so many mobile stocks, it will react to the earnings reports from the sector. I believe the reports will generally be positive, but XLK offers protection in the form of diversity. Having so many companies means that any one negative report is not going to pull XLK down. However, if we see a string of negative reports XLK will almost certainly trade lower, which is why I would want to double my protection by using a hedged trade on the ETF.
Chart courtesy of www.stockcharts.com.
A nice hedged trade on XLK would be the January 27/30 bull put credit spread. In this trade, you would sell the January 30 put while buying the same number of January 27 puts for a credit of 22 cents. This trade has a target return of 7.9%, which is 30.7% on an annualized basis (for comparison purposes only).With XLK currently trading at $32.67, this trade has 7.5% downside protection.