Nearer term, the Jan. 22 peak marked the beginning of the first of three sub waves dividing wave 2 {+1}. Wave A will itself be divided into five waves, and XLV is presently in wave 1 {-1} to the downside.
The stock price declined by 1% over the 15 day life of my position, or -23.7% annualized. The options spread produced a 4% loss on risk, or -97.8% annualized.
Click on chart to enlarge.
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| XLV 3 yers 2-day bars (left), 180 days 4-hour bars (right) |
Update 1/9/2014: I've opened a bull position in XLV, structuring it as a bull call spread, expiring in June and bought for a debit. The position has 2.7x leverage, and the long leg has a 56% probability of expiring in the money for a profit.
XLV engaged in some funny business near the end. It turned to the downside with 35 minutes to go before the closing bell, dropped sharply for 15 minutes and then took it all back with a sharp, five-minute rise. At that point I decided to open the position, in part because the shares are up from the opening price for an intraday rise, and the late, brief decline did nothing to alter that fact.
The exchange-traded fund that tracks health care, XLV, is in the early stage of a rise of an uptrend that began in August 2011. However, that first stage within the uptrend is itself nearing an end, to be followed by a correction of the rise from $29.74 to today's high, so far, of $56.56.
The Chart
I'll take the big picture first and then drill down through the Elliott wave count.
At the highest degree that I've counted, XLV began an uptrend on March 6, 2009 from $21.63. It can be labeled wave 1 {+4}.
The internal pattern is five waves to the upside. XLV is in the middle wave of the set, wave 3 {+3}, which began July 1, 2010 from $27.49.
Click on chart to enlarge.
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| XLV 3 years 2-day bars (left), 20 days 15-minute bars (right) |
XLV is presently within wave 1 {+1}, the first leg of the uptrend that began in August 2011, and that internal first wave is nearing its end. At present, it is working through wave 5 {-1} of wave 5, the latter having begun Aug. 28, 2013 from $48.82.
Of greatest concern to nearer term traders, like me, is wave 5 {-1}, the final leg up of wave 5. Wave 5 {-1} began Dec. 17, 2013 from $53.40 and is tracing out its middle wave, 3 {-2}, which began Jan. 6 from $54.95.
This tells me that a correction is in the works some time soon, triggered at the {-1} degree and its parent.
Wave 3 {-1} lasted five months, which makes wave 5 {-1}, at three weeks, a comparative youngster. There's no rule in Elliott that requires waves at the same degree to be time proportionate, but often they are, roughly at least.
The relative durations suggest that there is room for a further rise in XLV before the uptrend is exhausted.
The starting point of the present wave 3 {-2} is key. If XLV drops below that level, then the {-2} degree has ended, a correction is underway and my count is wrong.
XLV, as an equities exchange-traded fund, has a problem that is common to the species. It's diverse, being composed of a number of symbols. The bulls and the bears tend to cancel each other out.
This is reflected in the odds analysis, which shows XLV to be reliable in its bull signals but with little magnitude behind them.
Wave 3 {+2}, from August 2011, has completed 13 bull signals. Eight were successful, on average yielding 2.8% over 33 days. The five unsuccessful trades lost 2.4% over 15 days.
Wave 5, from August 2013, has completed three bull signals. Two were successful, yielding 0.6% over 18 days, on average. One failed, losing 1.3% over 10 days.
The resulting win/lose yield spreads are, frankly, pathetic. The longer term wave 3 {+2} spread is only 0.4%, and the near-term wave 5 spread is negative 0.7%.
The Fund
XLV is formally called the Health Care Select Sector SPDR Fund and is run by State Street Corp. based in Boston, Massachusetts.
Think household names in health and you've got a fair handle on XLV's holdings. The five companies holding the largest percentage of net assets are, in descending order, JNJ, PFE, MRK, GILD and BMY. Together they account for 37.6% of the total portfolio.
Note that all five are drug companies. It's not until 8th on the list that the first health insurance player, UNH, is encountered.
The expense ratio is 0.18%.
XLV goes ex-dividend in March for a quarterly payout of 22.5 cents, producing an annualized yield of 1.5% at today's prices.
Liquidity and Volatility
XLV on average trades 5.8 million shares a day and supports a wide selection of option strike prices spaced a dollar part, with open interest running to three and four figures near the money.
The front-month at-the-money bid/ask spread on calls is narrow, at 3.5%.
Implied volatility stands at 15% and has been tracking sideways since mid-November. It is at the 57th percentile of the three-month range, which is a neutral level, suggesting that the best trade would be long shares.
However, that range contains two significant outliers, one to the upside and one to the downside. Tossing the outliers moves the analysis to the 35th percentile, a low reading that suggests long options spreads have the best chance of success.
Options are pricing in confidence that 68.2% of trades will fall between $53.96 and $58.80 over the next month, for a potential gain or loss of 4.3%, and between $55.22 and $57.64 over the next week.
Contracts are trading actively today, with calls running at 167% above their five-day average volume and puts at 46% above average.
Decision for My Account
The best argument against XLV is that the weak win/lose yield spread, and the subsequent options analysis suggest that the fund is not a big winner.
However, such restrictions can be handled through leverage and by constructing options positions that profit if the price goes nowhere. Vertical spreads are very good at this sort of thing.
I intend to open a bull position in XLV, structuring it as a bull call spread, bought with a debit and expiring in June. I'll make the trade today if upward momentum continues into the half hour before the closing bell. Otherwise, XLV will go on the Watchlist as a potential trade.
References
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.
Disclaimer
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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