Monday, January 27, 2014

The Market: Has the apocalypse arrived yet?

Update 4/23/2014: SPY moved above its 20-day price channel today and I've removed it from the Roll Shelf. Any further bear positions in SPY will be the result of a new break with confirmation below the 20-day price channel.

I began the SPY bear series on Jan. 27 and rolled it forward on April 14. Both positions lost money.

Taken together, SPY shares rose 2.9% over the 16 days I held the positions, or 65.1% annualized. My options spreads produced a 35.5% loss on risk, or -797.2% annualized.

In the chart below, I've made an attempt to put an Elliott wave frame on the price movements after the April 4 peak, wave B {-2}. I've marked with a red line the upper boundary of the 10-day price channel, the level that signaled no further rolls for the SPY series.

The chart is a textbook example of why Elliott wave analysis should be considered to be a frame, an artificial method of trying to understand a chart, rather than unquestioned truth. The ambiguities on the chart at this relatively small degree are legion.

The frame I've imposed on the chart shows wave C {-2} to the downside is underway, in accordance with the earlier count. 

Within that decline, wave 1 {-3} ended on April 11 and wave 2 {-3} is now underway, or perhaps ended at $188.40 on April 22.

It's impossible at this point to say whether the relative degrees are correct. I may be looking at waves that are several degrees below the {-2} degree. There's simply no way to know.

A move above the April 4 high, $189.70, would invalidate the subsequent count shown below/

Click on chart to enlarge.
SPY 51 days hourly bars

Update 4/21/2014: I've rolled out my bull position after SPY hit its stop/loss point. The symbol remains on the roll shelf and I won't calculate results unless it moves above its 10-day price channel.

Update 4/14/2014: SPY has been sitting on the Roll Shelf since my options position expired in February. On April 10 it closed below the 20-day price channel and confirmed it the next day, opening an opportunity to roll back into a bear position.

I've opened bear calls spreads on SPY, short the $184 strike and long the $188, sold for credit and expiring in May.

On the chart, the problem with SPY has been identifying the B-wave peak, and it has kept eluding a definition that will stick. The magnitude of the decline since the April 4 peak at $189.70 suggests to me that this is the real deal. If not, then that's what stop/losses are for.

Click on chart to enlarge.
SPY 90 days 1-hour bars

Update 1/27/2014: The S&P 500's avatar, the exchange-traded fund SPY, showed downward momentum with half an hour to go before the closing bell, and I've opened a bear position. I structured it as a bear call vertical spread, sold for credit and expiring in February.

The position has a 66% chance of expiring out of the money for maximum profit.

There has been much talk over the weekend, both bearish and not so much, about last week's 3.1% decline in the S&P 500, as exemplified by its exchange-traded fund SPY.

Days like Friday, which saw a 2.1% decline, never fail to remind me of an exchange in Buffy the Vampire Slayer season 5 episode 22, "The Gift":
Buffy: This is how many apocalypses for us now?
Giles: Oh, uh, six at least. Feels like a hundred.
And so it does.

When the apocalypse strikes, I follow my instincts. I go to the chart.

On the SPY chart, I count at least 10 short-term declines of similar magnitude since Oct. 4, 2011, when the present uptrend began. (See the left chart.) If this be the apocalypse, then it is of a very common sort, like major winter snowstorms in New York, earthquakes in California or rain in the Pacific Northwest.

The Chart

Using Elliott wave analysis, I count the Jan. 15 peak of $184.94 as being the end of wave 3 {-1} to the upside. That wave began on Aug. 28, 2013 from $163.05.

SPY has begun wave 4 {-1} to the downside, correcting the rise of the last five months.

How much of a correction we'll see, no one can say.

Click on chart to enlarge.
SPY 3 years 2-day bars (left), 180 days 4-hour bars (center), 15 day 15-minute bars (right)
SPY can be expected to remain above the $163.05 mark during wave 4 {-1}, and also below the $184.94 mark. A break beyond those levels would mean that my count is wrong, and I would have some work to do.

There are several points where corrections often stop, or at least pause. They are called Fibonacci retracement levels, named after the Medieval mathematician, Leonardo Fibonacci, who introduced Arabic numerals to western Europe.

The most common stopping points are 38.2%, 50% and 61.8%.

A decline to the 38.2% level from today's opening price would bring SPY down to $176.58; to the 50% level, to $174; and to the 61.8% level, to $171.41.

Those levels suggest downside potential of between 1.4% and 4.3%. That's what the chart suggests, but it's not guaranteed. The correction could stop right now, or it could proceed to a decline of as much as 8.9%.

Under the Elliott wave model, after the wave 4 {-1} corrections is complete, SPY will move into a final uptrend that will carry it to a point above $184.98, perhaps significantly above, but perhaps not.

At the very near term, I count SPY as being in the third, or middle, wave within wave 4 {-1} to the downside. There's no way at this point to say how many degrees below {-1} that third wave stands. I've labeled it, arbitrarily, as wave 3 {-4}.

Liquidity and Volatility

SPY on average trades 109.3 million shares a day, more than any other symbol on the U.S. markets.

It has the widest selection of option strike prices available for any symbol, with strike prices spaced a dollar apart and near-the-money open interesting running to five and six figures.

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

Implied volatility stands at 18%. It rose sharply last week and is at a high level, the 75th percentile of the annual range. Implied volatility stands 75% above 90-day historical volatility.

Those high levels of volatility mean that the best way to structure a trade is as a short options spread, such as a bear call vertical spread.

Options are pricing in confidence that 68.2% of trades will fall between $169.20 and $187.68 over the next month, for a potential gain or loss of 5.2%, and between $174 and $182.88 over the next week.

Contracts are trading actively today, with puts running 75% above their five-day average volume and calls at 69% above average.


SPY goes ex-dividend in March for a 98-cent payout yielding 1.88% annualized at today's prices.

Decision for My Account

I already own a long-term bear position in SPY that I use to hedge systemic risk. I intend to open a fresh bear position in SPY if downward momentum continues in the half hour before the closing bell, and earlier if a sharp down slide develops. I'll structure the position as bear call spreads, sold for credit and expiring Feb. 21.


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. The principal practitioner 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

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

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.

No comments:

Post a Comment