Tim Bovee, Private Trader: KRE: Not all zags are equal

Update 8/22/2014: KRE closed above its stop/loss level on Aug. 21 and confirmed the exit signal the next trading day. I've exited my bear position for a loss.

The stock price rose 0.09% over the 35-day life of the position, or 0.96% annualized. A small amount, but the position was synthetic short futures constructed from options, a highly leveraged position. The options had a negative 44% yield on debit, or -458.9% annualized.

In the chart below, I've updated the Elliott wave framing, focusing on the period folloiwing the March 21 high that ended the most recent uptrend.

The symbol, by my count, remains in a downtrend and is undergoing a countertrend correction. I've labeled it as an A wave within a Zig-Zag, with five waves internally. However, at this point it could just as well have three waves internally as part of a Flat. Or, potentially, KRE may be tracing out a triangle. It's too early to tell.

Click on chart to enlarge.

KRE 5 months 4-hour bars

At any rate, it was a shorter-term trade, and my rules got me out with some damage, but far less than it might have been.

KRE's upward move put it above the 10-day price channel, so the symbol won't be placed on the Roll Shelf.

Update 7/18/2014: KRE will close above its opening for the day. However, it came off of its highs and is showing sufficient intra-day downside momentum for me to trade.

I've opened a bear position in KRE, structuring it as a synthetic short future, simultaneously short and long the $39 put that expires Dec. 19.

The SPDR KBE Regional Banking exchange-traded fund (KRE) has broken below its 20-day price channel for the third time in the past year.

Traditional chart analysis would dismiss KRE's most recent decline as yet another zag in a zig-zag sideways move.

But not all zags are created equal, at least not in their significance.

A structural analysis suggests that KRE each leg down has a wildly different significance, and this 3rd leg begins a significant decline.

The Chart

I've marked the 20-day price channel boundary, as it stood on Thursday, on the right-hand chart, with read arrows marking the three crossings under discussion.

Click on chart to enlarge.

KRE 5 years weekly bars (left), 1 year 2-day bars (right)

Elliott wave analysis shows that the first crossing was a final counter-trend correction near the end of a larger rise that began on Oct. 3, 2011. That movement peaked on March 24 of the current year.

The second crossing was the first wave down of a counter-trend correction to a rise that began March 6, 2009, a correction whose magnitude is so large that it could conceivably carry the price below the $30 level, a loss of half the stock's value.

The third crossing is the second wave down in that counter-trend correction. Third waves are typically the most energetic of the wave set and, when they're declining, do the greatest damage to bull positions.

That, at least, is the most bearish scenario that Elliott wave analysis can find in this chart.

Not all corrections are deep dives, however. Some turn out to be shallow movements that do less price damage but that extend sideways. If that proves to be the case, then traditional analysis will have been correct in dismissing this third breakout as being of little significance, although incorrect in lumping all three breakouts together as the same sort of beast.

The correction from the March 24 peak is still in early days, and the nature of that correction, deep or shallow, won't be known for many months to come.

In the nearer term, since the decline of July 11 is a 3rd wave, I would expect it to move below $35.10 at a minimum, and perhaps significantly below that level.

Wave 1 lasted 52 days, and the present wave 3 has been underway for only a week. I wouldn't be surprised to see wave 3 endure into September.

Odds and Yields

KRE has completed one other bear signals since the March 24 peak. It was successful, yielding 1.5% over 36 days. That's a fairly low yield. Since the present bear signal is coming in a third wave, I would expect the yield to be greater.

The Fund

KRE tracks the S&P Regional Banks Select Index. Its holdings are spread quite evenly, with the top 10 ranging from 1.41% to 1.49% of net assets.

Just to give a flavor of what the fund is about, some of its top holdings are Popular Inc., Bank of the Ozarks, Signature Bank, Iberiabank Corp. and Glacier Bancorp Inc.

The expense ratio is 0.35%, compared to a 0.09% expense ratio for SPY, the most traded fund on the U.S. markets.

KRE's dividend yields 1.53% annualized at today's prices, compared to 2.49% for 10-year U.S. Treasury notes. The stock goes ex-dividend in September for a quarterly payout of 16.71 cents per share.

Liquidity and Volatility

KRE on average trades 2.6 million shares per day and supports a wide selection of option strike prices spaced a dollar apart, with open interest running mainly to three figures near the money.

The front-month at-the-money bid/ask spread on puts is 9.3%, compared to 0.4% on SPY.

Implied volatility stands at 22%, compared to 12% on the S&P 500, and has been working its way higher since late June.

Volatility is in the 47th percentile of the one-year range, meaning that short shares or an options equivalent, such as synthetic short futures, have the greatest chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $36.45 and $41.39 over the next month, for a potential gain or loss of 6.3%, and between $37.73 and $40.11 over the next week.

I've marked the month-range on the left-hand chart in blue.

Contracts today are skewing heavily toward puts, which are running 78% above their five-day average volume. Calls are running at 37% of average volume.

Decision for My Account

This is a reasonable bear play, although an unexciting one, because of the low volatility common to funds. Volatillity on individual stocks tends to be higher.

As I wrote this analysis KRE was rising, coming close to crossing back into the 20-day price channel. However, it has reversed and is again on the decline.

I intend to open a bear position in KRE if it shows downward momentum in the half hour before the closing bell. If momentum falters again, then I shall place it on the Watchlist. I'll structure the position as a short synthetic future built out of options.

-- Tim Bovee, Portland, Oregon, July 18, 2014

References

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

I from time to time 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 shorter-term 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 decisions for his or her own account, and take responsibility for the consequences.