Wednesday, September 11, 2013

GDX: Gold mining bear play

Update 10/21/2013: GDX closed above its 10-day price channel, signalling that I should close my bear position. I opened the position on Oct. 2; there was a trading error in opening an earlier position based on this analysis and I've excluded it from the results.

The price pushed to lower lows steadily until Oct. 15, when it began a rise that pierced the price channel two days later but quickly withdrew, again piercing and closing above the level on Oct. 21.

Oct. 15, of course, was the day it began to become clear that Congress would end its dispute over government funding without defaulting on the national debt.

The stock price rose 1.6% during the 19 days I held the bear position. The position was structured as a bear calls spread, which had a 6.9% yield on risk, or 131.6% annualized.

The Market Vectors Gold Miners exchange-traded fund (GDX) is a train I caught on its bull run in mid-August, and now in mid-September, I have a chance to hop aboard again for the bear run.

My bull play was a disappointment, ending with a small loss. (See "GDX: Trends within trends" posted Aug. 15 and updated with results on Aug. 29.)

It is clear that GDX has long made more sense as a bear play. Back in August I wrote,
The problem with gold is that it has been on the slide for so long, no one can believe that it may indeed be on the rise again, me among them. I nearly relegated GDX to a [no trade] posting, so unlikely the idea of an upside breakout in gold appears to be.
Would that I had listened to my inner skeptic.

In August, I concentrated on a shorter-term GDX chart, the 90-day chart with one-hour bars.
GDX 3 years 2-day bars

This time around, I'm looking at the longer-term trend, and if I take the trade, perhaps that will give me better results. Knock on wood.

GDX began its present downtrend from $66.98 in September 2011 and has completed four waves of a five-wave track, using Elliott wave analysis.

I count the fund as being in a fifth and final wave down, a move that will be followed by a three-wave correction to the upside, a zig-zag most likely, or possibly a flat.

The important point for a shorter-term trader like me lies in Elliott wave doctrine: The fifth wave in a downtrend must fall below the end of the third wave, in this case, below $22.21, the low attained on June 26.

The fifth wave began from $31.35 on Aug. 27, and the low so far today is $26.20. That means by Elliott wave rules GDX has 15.2% at a minimum to fall, and of course it could be much more.

So the chart says GDX has a reasonable chance of being a profitable trade to the downside.

The odds back up that claim.

This is the ninth bear signal since the present downtrend began in September 2011. Seven of the completed signals were profitable, yielding 8% on average over 35 days. The failed trades lost 17% over three days.

The magnitude of the failed trade produces a negative win/loss yield spread. It turns out that the huge loss came with the breakout that I played in August. My stop/loss point got me out before GDX reached its maximum loss.

GDX is one of 35 symbols that survived my screening last night. (See "Wednesday's Prospects".)

To cut down the field to a manageable size, I tossed out everything with average volume under 2 million shares a day, leaving eight symbols.

Of those, two failed confirmation by returning within their 20-day price channels: AMD and FLEX.

AMTD confirmed its bull signal, but it is trading down today. It's not a firm rule, but I prefer for a breakout trend to continue on confirmation day.

ETN was a bull signal, but the symbol is rated bearish by Zacks. Where I have a choice, I prefer for the direction of the breakout and Zacks' fundamentals-based analysis to be aligned.

TWM is an ultra short fund based on the Russell 2000. I tend not to trade such funds, preferring a more straightforward approach.

HL is priced under $10, which makes it difficult generally to construct an options spread; I have to sell so many contracts that the fees start to eat into my potential profits.

That left me a choice between a bull signal on BA and a bear signal on GDX. I'm over exposed at this point on bull positions, so I decided to try GDX first to see if I had a trade.

The Gold Miners ETF is a composite of the largest gold mining companies, with a quarter of the fund's holdings in two: Goldcorp Inc. (GG) and Barrick Gold Corp. (ABX).

Gold, like oil, is highly susceptible to news. Great power military involvement in Syria, if it happens, could well affect the price of GDX, although I wouldn't venture to say in which direction.

GDX on average trades 41 million shares a day. It has an extremely wide selection of option strike prices with four-figure open interest dominating the grid. The front-month at-the-money bid/ask spread on calls is extremely narrow, at 1.8%.

Implied volatility stands at 46%. It has been zig-zagging sideways since late July.

Options are pricing in confidence that 68.2% of trades will fall between $22.89 and $29.79 over the next month, for a potential gain or loss of 13.1%, and between $24.68 and $28 over the next week.

Trading in options is quite active today. Calls are running at two-and-a-half times their five-day average volume, and puts are at 35% above average volume.

The fair-price zone on today's 30-minute chart runs from $26.21 to $26.61, encompassing 68.2% of transactions surrounding the most-traded price, $26.54. GDX opened above the zone and in the first hour of trading fell to the zone floor, from which it bounced up to the most-traded price.

GDX goes ex-dividend on Dec. 24 for an annual payout yielding 1.75% at today's prices.

Decision for my account: I don't have any of the misgivings over this bear play that I had over August's bull position. For a bear trade, GDX has a good chart and excellent odds.

I've opened a bear position in GDX, structuring it as a short vertical options spread. The leverage is 1.9:1, and the maximum yield on risk at expiration is 26.7%. The hedge is a 1.8% margin of profitability at expiration above the entry price.

My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

At several points in my analysis I use the number 68.2%. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. StockCharts has a good explainer. The principal practioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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