Friday, November 8, 2013

EWZ: Bearish on Brazil

Update 3/20/2014: I've closed my bear position in EWZ, the second in a roll series. The overall series was profitable, although the second and final position was a loss. I don't intend to roll EWZ forward into a new position.

I entered the second bear position on Jan. 23. It hit a low on Feb. 3 and thereafter went on a meandering journey between the boundaries of the 10-day price channel, which provides exit signals. Due to ambiguities in my exit rules, which I'm in the process of revising, I held on to the non-performing position longer than I should have.

The Elliott wave count for EWZ's chart remains bearish.

Combined results for both positions: Shares declined by -6.5% over the 45-day lifespan of the positions, or 53.2% annualized. My options spreads produced a +102.5% yield on risk, or +834% annualized.

Click on chart to enlarge.
EWZ 3 years 3-day bars

Update 1/23/2014: EWZ has resumed its decline, which I count as the fifth wave of a C wave to the downside. My full locator is wave 3 {+1} of wave 3 {+2} of wave 5 {+3} of wave C {+4}. The C is like to move below the terminus of the A wave of the same degree, $26.24. The present wave 3 {+2} is near its minimum downside target, $40.68, but could well move much further to the downside.

I have rolled EWZ forward into a new bear position. Implied volatility is now in the middle of the annual range, at the 42nd percentile. Therefore, I've structured the position as a short synthetic future, long the put and short the call, with the same at-the-money strike price with both sides expiring in June.

Click on chart to enlarge.
EWZ 7 years 3-day bars (left), 2 years daily bars (right)

Update 11/8/2013: EWZ stayed below its breakout level but switched to upward momentum an hour after the opening bell, falling back a bit in the afternoon. The price remains below the high for the day and is trending net flat with 15 minutes to go before the closing bell, so I took the trade. 

The short bear put spreads, which expire in December, produces leverage of 8:1, with a potential maximum profit of 69.5% at expiration. The structure provides a 1.7% hedge of profitability at expiration above the entry price.

A shift in the markets toward a bearish tide washed in a lot of potential trades. The most liquid symbol of the 21 survivors tracks one of the former wunderkind of the developing markets, the country that put the B in BRICs -- Brazil. (Altogether 21 symbols survived my initial screening overnight. See "Friday's Prospects".)

EWZ -- the iShares exchange-traded fund that tracks the MSCI Brazil Index -- fell below its 20-day price channel on Thursday in a sharp decline tracing out 3.4% intraday high to low. In the process of falling, it broke below a reversal level set Sept. 30, adding to its downtrend creds.

The quartet of powerhouse countries that have spent several decades developing at a high pace -- Brazil, Russia, India and China, called the BRICs -- have long gotten great press. They were, in many ways, the ultimate story trades -- spunky third-worlders rising out of poverty to show the Great Powers how its done in the 21st century (and, in the process, to provide a place to make money when the Great Powers' economies fell into a particularly nasty recession).

But truth is, their shares saw their best days in 2008 with an echo in 2010 and have since been working their way downward, although with enough recoveries to the upside to keep bullish dreams alive.

Their reputation as a road to wealth hasn't been helped by articles in recent years with such headlines as "Broken BRICs" (Foreign Affairs) and "BRICs no longer a slam dunk" (CNBC), along with searches for the post-BRIC Next Big Thing, such as the CIVETS (Columbia, Indonesia, Vietnam, Egypt, Turkey and South Africa -- Wall Street Journal) or MIST (Mexico, Indonesia, South Korea and Turkey -- The Guardian).

I'm not going to try to count the EWZ chart using Elliott wave analysis. It's a bit messy and frankly, is scarcely worth the effort. It's a downtrending chart, both on the decade chart to the left and the 180-day chart to the right. (The vertical red line in the left-hand chart marks the beginning in time of the right-hand chart.)

EWZ 10 years weekly bars (left), 180 days 4-hour bars (right)

EWZ has shown fairly poor odds of success since last February's peak, mainly because of one big winner that put the rest to shame. Of four completed bear signals, only one was successful, but it had a yield of 16% over 34 days. The three unsuccessful bear trades lost 4.3% over 10 days, on average.

The most telling figure is the yield spread -- a positive 11.7%. I'll take that any day.

EWZ's top holdings are focused on finance, fossil fuels and mining - Itau Unibanco, Petrobras, Banco Bradesco and Vale, but also includes among the top five the beverage company Ambev.

EWZ on average trades 14.7 million shares a day and supports an awesomely wide selection of option strike prices spaced 50 cents apart near the money and a dollar apart further out. Open interest runs to four and five figures.

The front-month at-the-money bid/ask spread is only 1%.

Implied volatility stands at 29%, at the middle of the six-month range. It has been rising since Oct. 23.

Options are pricing in confidence that 68.2% of trades will fall between $43.22 and $51.24 over the next month, for a potential gain or loss of 8.5%, and between $45.30 and $49.16 over the next week.

Contracts are skewed to the put side today, with volume running 3-1/2 times the five-day average. Calls are trading at 83% of average volume.

EWZ goes ex-dividend in December for a semi-annual payout yielding 2.61% annualized at today's prices.

Decision for my account: I intend to open a bear position in EWZ if momentum persists in the last half hour before the closing bell. If momentum falters, then I'll add EWZ to my Watchlist for -- possibly -- later entry.

I'll structure the position as a bear call spread, sold for credit and expiring in December.


My shorter-term 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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