Friday, January 24, 2014

XLP: Bearish on consumer staples

Update 3/14/2014: XLP reversed to the upside, and I've closed the bear position for a heavy loss. The loss was magnified by the fact that the position was short synthetic futures.

The stock price rose by 2.6% over the 49-day life of the position, for an annualized change of 19%. The options spreads produced a negative 81% yield on risk over that period, for an annualized loss of 603.5%. 

Update 1/24/2014: I've opened a bear position in XLP, structuring it as a short synthetic futures, long the puts and short the calls, with identical at-the-money strike prices on either leg, with both expiring in June.

The leverage is about 3:1.

The consumer staples exchange traded fund (XLP) broke below its 20-day price channel on Thursday, sending a bear signal in the early stages of a retracement correcting the rise from $19.28 on March 9, 2009 to $43.46 on Nov. 18, 2013.

A decline of that magnitude will contain major uptrends and downtrends, and each provides an opportunity for profit. The present downtrend is on a scale that could take years to reach completion.

On the closer view, however, the present leg of the major trend can be expected to last for several months before itself encountering an upside correction of sufficient size to cause me to close any bearish position.

The Chart

XLP, like most major exchange-traded funds, tends to follow the S&P 500. The present 200-day correlation between the index and the fund is 79%, and it has been above 90% for much of the fund's existence.

XLP began trading in 2008, so I'm in the position of jumping into the story in mid-narrative.

In doing the Elliott wave analysis, I assume that the starting point of my count, the low reached in 2009, will closely correspond with the similar low set by the index, and the ensuing rise will be part of an upward correction, as it is in the index.

Click on chart to enlarge.
XLP 5 years 3-day bars (left), 180 days 4-hour bars (right)
My assumption means that the rise from 2009 is an upwards correction within a very long running downtrend, a rising wave A {+2} subdividing into a five waves at the {+1} degree that ended last November, and has been followed by a declining wave B {+2}, subdividing into three waves, of which the present wave A {+1} is the first.

Wave A {+1}, like all A waves, also subdivides into five waves. I count the present wave to the the middle on, wave 3, of the series.

My "You Are Here" for XLP, then, placed the symbol in wave 3 of A {+1} of B {+2} to the downside.

Under the Elliott wave rules, wave 3 must move lower than the terminus of wave 1, which was $41.69 on Dec. 18, 2013. Today's open, $41.80, stands 0.3% above that level.

If the price reverses and moves decisively to the upside, then my count is incorrect. A break below $41.69 confirms my count. That level need not be the end of the decline. There's nothing in the Elliott wave rules that forbids wave 3 from falling quite a bit further.

The Odds

At this point in XLP's career the bearish odds are fairly meaningless. The price has been on the rise for nearly five years, with only shallow corrections.

Since the final correction of that rise began, on Oct. 9, 2013, there has been but one bear signal besides the present one. It was a failure, losing 1.4% over 11 days.

I don't take that as a serious predictor of how the present bear signal will pefform. There's a world of difference between an uptrend correction and a full-monty downtrend.

The Fund

The Consumer Staples Select Sector SPDR Fund places its funds in companies that might be described as providing the staves of life: Food, beverages and household and personal products.

Its top five holdings give a flavor of its focus: Procter & Gamble, Coca-Cola, Philip Morris International, Wal-Mart, CVS Caremark. A few steps down the holdings chain comes Costco.

These are household names, and they make or sell stuff we use every day.

The fund's expense ratio is 0.18%. The dividend yield is 2.46% at today's prices.

XLP goes ex-dividend in March for a quarterly payout. The  most recent dividend was 32.21 cents.

Liquidity and Volatility

XLP on average trades 7.2 million shares a day and supports a wide range of option strike prices spaced a dollar apart. Open interest near the money runs to four and five figures.

The front-month at-the-money bid/ask spread on puts is 4.8%.

Broad funds are, by nature, hotbeds of moderation.

XLP's implied volatility stands at 14%, compared to 16% for the S&P 500,  and has been trending sideways since mid-October. It is in the 51st percentile of the annual range, almost perfectly midway between the high and the low, and is slightly above its 60-day historical volatility.

The best way to structure a position, given that level volatility, is as short shares or an equivalent, such as a synthetic short futures position built from options.

Options are pricing in confidence that 68.2% of trades will fall between $40.10 and $43.48 over the next month, for a potential gain or loss of 4.1%, and between $40.98 and $42.60 over the next week.

Contracts are trading actively today, with puts running at more than double their five-day average volume and calls at 35% above the average.

Decision for My Account

The chart is bearish in  my opinion, and if I'm wrong, I'll soon know it.

If downside momentum continues into the half hour before the closing bell, I shall open a bear position in XLP, structuring it as synthetic short futures built from options and expiring in June. The position gives me 4:1 leverage, a necessity with a lower volatility symbol.

If momentum falters, I'll add XLP to my Watchlist for further consideration.


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.

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