Monday, October 14, 2013

KRE: Regional banks' hope and woe

The SPDR KBW Regional Banking exchange-traded fund (KRE) broke above its 20-day price channel on Friday and confirmed the bull signal by trading above the breakout level today.

KRE is designed to track the S&P Regional Banks Select Industry Index. A regional bank is larger than a community bank but smaller than a money center bank. It operates within a state but in multiple cities and towns.

More than half of the market capitalization of KRE and its underlying index come from small-cap banks, all of which account for less than 2% of the total portfolio.

The top 10 holdings account for 16.1% of assets, led by East West Bancorp Inc., Firstment Corp. and PacWest Bancorp. U.S. banks account of 96.5% of KRE's exposure; the remainder is in Puerto Rican banks.

The regional banking sector is telling two contradictory stories: A signal of bullish hope from the breakout and a tale of bearish woe from the chart pattern.

Elliott wave analysis of the chart shows five waves up from $24.80 on June 5, 2012, peaking at $37.72 on Aug. 5, 2013.

KRE 3 years daily bars

The wave pattern since August has been anything but clear. I would guess, based on a corresponding count for blue-chip stocks, that the decline shows the start of a five wave downtrend.

However, I would need to see a clear down wave followed by an upward retracement and then a resumption of the downward march. So far, that's not apparent. The stock is down, but it is not trending strongly.

If KRE is indeed correcting the rise from June 5, 2012, then the present decline should, under the rules of Elliott wave analysis, stop short of $32.34, the end of wave 4 one level lower than the rise ending with wave (C) last August.

(Elliott wave analysis identifies trends within trends, viewing the markets as a fractal object.)

At any rate, the one truth that is clear from the chart is that KRE has been in a downtrend since August, a bearish pattern.

The break beyond the 20-day price channel was to the upside, sending a bull signal. Under my rules I can't open a bull position while a stock is trending downward.

KRE was one of three symbols that survived initial screening over the weekend, all having broken out to the upside. (See "Monday's Prospects".)

The one corporate stock in the batch, HOLX, had an earnings notice flash this morning, meaning it now comes within my 30-day period that forbids opening new positions that close to an earnings announcement.

The other symbol, also an ETF, is IWN, which tracks value stocks listed in the Russell 2000. There's no reason not to consider it for a trade; its shares and and options both have adequate liquidity. But it is less liquid than KRE, so I set it aside. At this point, with time pressing, I note that it's a bull signal, and I'm still opening only bear positions until the question of a possible default on the American national debt is settled. So, I won't do any further analysis on it.

KRE, issued by State Street Global Advisors, has an expense ratio of 0.35%.

On average it trades 3.1 million shares a day, sufficient to support a wide selection of option strike prices spaced a dollar apart, with open interest running to three and four figures. The front-month at-the-money bid/ask spread on puts is 3%.

Implied volatility stands at 24%, at the middle of the six-month range. It has risen sharply from 22% over the last two days, the low point of a rapid decline from 28% on Oct. 9.

Options are pricing in confidence that 68.2% of trades will fall between $34.11 and $39.21 over the next month, for a potential gain or loss of 7%, and between $35.43 and $37.89 over the next week.

Trading in contracts today is leaning toward the put side, with volume running nearly three times the five-day average. Calls are languishing at merely 60% of the average volume.

KRE goes ex-dividend in December for a quarterly payout yielding 1.7% annualized at today's prices.

Decision for my account: The contradiction between the bullish hope of the price channel breakout and the bearish woe of the chart is a deal killer. I won't be trading KRE today and, given the present bearish bias of my trading while the U.S. government is trying to figure out whether to actually pay its bills, I won't be adding it to my Watchlist.


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

I use the number 68.2% in using applied volatility to calculate the expected trading range. 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

By preference I place my trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

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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