Tuesday, February 11, 2014

XLV: Health care redux

Update 3/26/2014: My bearish opinion was correct. XLV gave an exit signal by moving below its 10-day price channel and I've removed it from the Roll Shelf.

XLV shares rose 2.6% over the 27-day life of my position, or 34.5% annualized. The options produced a 13.5% yield on risk, or 181.8% annualized.

Update 3/12/2014: I've rolled out of my bull position in XLV. The options spreads expire March 22.

The decline from the $60.50 peak set March 6 suggests that wave 2 {+1} to the downside has begun. A move above $60.50 would mean that analysis is wrong.

I won't roll back in until the wave count becomes clearer.

Click on chart to enlarge.
XLV 180 days 2-hour bars

Update 2/13/2014: Trading was up today and I opened a bull position, structuring it as bull put vertical spreads expiring in March and sold for credit.

Update 2/12/2014: XLV closed above its 20-day price channel, confirming the prior day's bull signal. However, it was a down day and I opened no position, opting instead to put XLV on the Watchlist for later consideration.

The exchange-traded fund that tracks the heath-care sector, XLV, has again broken above its 20-day price channel, seconding the second bull signal in as many months. The breakout has not yet been confirmed. For any trade to happen under my rules, XLV will have to trade above the breakout level of $57.50 on Wednesday.

The bull play that I analyzed on Jan. 9 in "XLV: Bullish on health care" reversed on Jan. 22, starting a correction that lasted until Feb. 4.

In a discourse on the nature of analytical systems, I wrote: "A system that knows that new information means that the prior analysis was wrong and proudly proclaims it is a system imbued with high virtue." (See "The Petroleum Triangle: A case study".)

The XLV chart is another example of that virtue at work.

The Chart

XLV's rise above the Jan. 22 high made my prior Elliott wave count invalid. The higher high meant that Jan. 22 could not be the end of wave 5 within wave 1 {+1}.

The new information tells me that wave 5 has extended and by doing so has extended the range of wave 1 {+1}. Far from having moved into a downtrend, the new information proclaims, XLV's rise continues.

However, wave 1 {+1} remains in its final leg up according to my revised count, which is wave 5 {-2} of 5 {-1} of 5 of 1 {+1} of 3 {+2} of 3 {+3} of the rise from March 6, 2009.

Click on chart to enlarge.
XLV 5 years 3-day bars (left), 4 months 1-hour bars (right)
In my opinion that rise can be best labeled as wave 1 {+4} within 1 {+5} of a very long-running uptrend. That label, however, arguably puts the health-care sector at odds with the trend of the broad market.

The alternative is to label the rise as wave A {+4} of B {+5} of an upside correction.

The choice makes little difference to trader's with my shorter time horizon and is mainly of interest to Ellioticians of a more theoretical bent.

Odds and Yields

This is XLV's 15th bull signal since the present wave 3 {+2} began on Aug. 9, 2011. Eight of the breakouts produced a profit, yielding 2.8% over 33 days on average. The six failures lost 2.2% over 15 days on average.

The resulting yield spread, 0.6%, is quite small, but that lack can be overcome with leverage. The odds show the uptrend's persistence with a slight bias against whipsaws.

The Fund

For fund information see my analysis from last January, here.

Liquidity and Volatility

XLV on average trades 11.4 million shares a day, sufficient to support an extremely wide range of option strike prices spaced a dollar apart with open interest near the money running to four and five figures. The front-month at-the-money bid/ask spread on calls is 4.7%.

Implied volatility stands at 17% and has been falling since hitting a one-year peak of 23% on Feb. 3. That puts volatility at the 60th percentile, just at the entry point to the high range. Implied volatility stands 18% above historic volatility.

The higher level of volatility suggests that the fund would best be traded as a vertical spread sold for credit, such as a bull put spread.

Options are pricing in confidence that 68.2% of trades will fall between $54.84 and $60.34 over the next month, for a potential gain or loss of 4.8%, and between $56.27 and $58.91 over the next week.

Contracts were trading relatively slowly on Tuesday, with both calls and puts running at about a third of their five-day average volume.

Decision for My Account

I intend to open a bull position in XLV if the breakout is confirmed and the uptrend continues in Wednesday's trading. If either test is failed, then I shall add XLV to my Watchlist for further consideration as a bull play.


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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