Wednesday, February 26, 2014

XLY: Correction over?

Update 3/25/2014: I close my XLY position on March 14 after it flirted with the lower boundary of the 10-day price channel, moving it to the Roll Shelf. On Monday it moved decisively below the channel and is trading considerably lower today.

So I'm removing XLY from the Roll Shelf and no longer consider it to be a potential trade for the near future. A fresh bull or bear signal would bring it back under consideration.

The chart shows that XLY might well still be in an uptrend, although it could also, arguably, have completed its upward run and moved to the early stages of a downtrend.

I've added an internal count to wave 5 {+2} that makes the bearish case for wave 5 {+2} having peaked at $67.85 on March 7. A decline below the start of wave 5 {+1}, $61.03 on Feb. 3, would confirm the bearish argument. A rise above $67.85, which I've counted as the end of wave 5 {+1} would confirm the bullish case.

I held one position in XLY. Its shares lost 1.7% over the 10-day life of the position, or -61.5% annualized. The options spreads produced an 8.2% loss on risk, or -300.2% annualized.

Click on chart to enlarge.
XLY 3 years 3-day bars
Update 3/4/2014: XLY broke above the $66.85 level today, confirming that wave 5 {+1} to the upside has indeed begun.

I've opened a bull position, structuring it as a bull put options spread, sold for credit and expiring in April.

The exchange-traded fund that tracks consumer discretionary spending, XLY, is nearing the final stages of its rise from June 2013 -- maybe. The chart will remain ambiguous until the price pushes above its high of Dec. 31, 2013, when the price reached $66.85 before reversing into a correction.

Tuesday's break above the 20-day price channel boundary at $65.90 was a step toward resolving that ambiguity and a higher high today confirmed the bull signal.

However, until the $66.85 barrier is breached, the possibility will remain that XLY's correction is still underway, with a period of decline or churning in the near future.

The Chart

The question is the placement of wave 5 of 3 {+1} in the right-hand chart. The magnitude of the ensuing decline to $61.03 on Feb. 3, in wave 4 {+1}. The magnitude suggests that labelling is correct and that wave 3 {+1} did indeed end on Dec. 31, 2013.

However, wave 4 {+1} could just as easily be labelled wave A within an ongoing wave 4 {+1}.

Click on chart to enlarge.
XLY 5 years weekly bars (left), 1 year daily bars (right)
A reversal below the Dec. 31, 2013 peak of $66.85 will confirm that wave 4 {+1} is still underway, with wave A to be followed by waves B and C in what could prove to be either a decline or a sideways correction.

A break above $66.85 will confirm that wave 5 {+1} is indeed in progress.

Odds and Yields

XLY has completed six bull signals since beginning its rise on June 24, 2013. Five were successful, each on average yielding 3.2% over 41 days. The failure lost 6% over 15 days.

The magnitude of the loss produced a disappointing negative 2.8% yield spread. The figures show that XLY isn't prone to whipsaws; its signals have credibility. The one loss was large enough that it calls the strength of XLY's momentum into question. However, one loss may well be an aberration rather than a pattern.

The Fund

XLY is the Consumer Discretionary Select Sector SPDR Fund, which tracks the classic presumptions that consumers drive the economic recovery.

It tracks companies that make and sell things that we buy when we're feeling well enough to spend a bit more freely, but they aren't necessities. Things like melas out or new cars or cable TV or athletic shoes.

The fund's top holdings are all household names: Comcast, Amazon, Disney, Home Depot, McDonald's, Twenty-First Century Fox, Priceline, Time Warner, Nike. They deal in everyday stuff we like but will forego if we hear the wolf scratching at the door.

XLY has an expense ratio of 0.16%, compared to the S&P 500 fund SPY's 0.09%.

It goes ex-dividend in March for a quarterly payout of 26.15 cents per share, which produces an annualized yield of 1.17% at today's prices.

Liquidity and Volatility

XLY on average trades 4.8 million shares a day, sufficient to support a wide selection of option strike prices with open interest near the money running to three and four figures. The front-month at-the-money bid/ask spread on calls is 3.8%, compared to 0.4% for the S&P 500 fund SPY.

Implied volatility stands at 15% and has been falling since reaching a one-year peak of 22% on Feb. 3.

Volatility is in the 37th percentile of the annual range. Historical volatility stands 13% above implied volatility. 

The low level of implied volatility suggests that long options spreads, such as bull call spreads, sold for credit will provide the best opportunity for success.

Options are pricing in confidence that 68.25 of trades will fall between $63.52 and $69.46 over the next month, for a potential maximum gain or loss of 4.5%, and between $65.06 and $67.92 over the next week.

Contracts on puts are trading 14% above their five-day average volume, and calls at 23% below average.

Decision for My Account

I'm adding XLY to the Watchlist and won't open a bull position until the price moves above $66.85, confirming that the present fourth-wave correction has indeed ended.


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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