Tim Bovee, Private Trader: XLP: Bearish on consumer staples, redux

Update 8/11/2014: XLP has moved above the stop/loss point and I've my bear position. The symbol moves over to the Roll Shelf. My practice is not to complete profit and loss until a trade series is complete.

The chart shows that XLP is still in a downtrend from the peak of $45.71 attained on June 19. It has been in a counter-trend rise since Aug. 8.

Click on chart to enlarge.

XLP 2-1/2 years hourly bars

Under Elliott wave analysis, wave 3 {+2} to the upside took four years and 10 months to complete its rise to a major top. The correction so far has lasted only four and a half months. So, it is early days. Not even the degree is certain.

Third waves are notoriously long lived, so I have no expecation that the wae 4 {+2} correction will also last for four years. However, I do anticipate that it will run into the latter half of 2015 at the shortest, and perhaps into 2016 or 2017, depending upon the form that it takes.

If the correction at this degree is taking the form of the pattern Elliott wave analysts call a Zig-Zag, then the present wave 4 to the upside will be followed by a wave 5 decline that will complete wave A {+1} of 4 {+2}. (Remember, the degrees below {+2} are a guess and may be smaller degrees than I've used here.)

If the correction is a Flat, then the Aug. 6 low completes wave a Zig-Zag and is being followed by wave X, a separating wave that in turn will be followed by another corrective pattern.

The correction so far hasn't even reached the 23.6% Fibonacci retracement level, the shallowest of the most common levels. So if this is the stopping point, it is a very weak correction indeed.

Other common stopping points are the 38.2% level ($37.78), 50% ($35.33) and 61.8% ($32.88).

There are never any guarantees with Fibonacci retracement points, but these levels are commonly seen.

Bottom line: Bear trend in progress; I've done a jack-rabbit exit under my rules; XLP remains on the Roll Shelf and I'll keep it in sight for a re-entry opportunity.

Update 7/30/2014: I've opened a bear position in XLP, structuring it as a bear put spread, long the $44 puts and short the $42.puts, bought with a debit and expiring in December.

The position has 13:1 leverage.

The Consumer Staples Select Sector SPDR (XLP) broke below its 20-day price channel on Tuesday and has confirmed the bear signal by trading still lower today.

The exchange-traded fund peaked in June and has since begun a downward correction that has potential for a significant decline in the next year and over the longer run.

We've played this song before, in an analysis posted last January, when XLP began its first leg down from the peak. That trade was closed in the ensuing second leg, to the upside. The third leg down has greater potential than did the first, so perhaps -- fingers crossed -- third time's a charm.

The Chart

Read enough charts and you'll be struck by their sameness.

Most stocks hit a Great Recession low in late 2008 or early 2009, and many began a new leg up in the ensuing rise sometime in 2010.

The nature of the rise is not always clear and is the subject of great debate among the Elliott wave analytical community. But the facts on the ground are indisputable: Most stocks have been rising for the past four years, and reason suggests that a correction of that rise may have already begun or, best case, can't be far away.

Click on chart to enlarge.

XLP 20 years monthly bars (left), 7 months daily bars (right)

XLP is in the middle wave of the rise from 2009 and in the final wave of that middle wave. In Elliott terms, the rise from the Great Recession low is wave 3 {+3}, and wave 3 {+2} -- the middle wave --began in May 2010. Down one degree, wave 5 {+1} began Feb. 3 from $39.83.

XLP peaked on June 19 at $45.71 and has since lost nearly 4% of its value.

Using Elliott wave analysis, I count the peak as the end of the rise from May 2010 and the three waves that followed the peak as the beginning of a counter-trend move that initially will correct the rise from Feb. 3 and ultimately, the the rise from March 2010.

It is possible, of course, that what I've labeled as wave 1 {+3} on the 20-year left-hand chart is in fact a 3rd wave of that degree, which would mean that the correction from the June peak will be much greater over time.

In reality, at such a large degree, the timespans involved are so great as to render such distinctions meaningless.

There is no way to say for sure how deep the corrections will be. They often reverse at the major Fibonacci retracement levels: 38.2%, 50% and 61.8%.

A 61.8% retracement of the rise from 2009, the {+3} degree, would bring prices down to $32.31; from 2010, the {+2} degree, down to $32.88; and from February -- the {+1} and lowest degree of the ongoing uptrend -- down to $42.06.

Calculating from the lowest point so far today, $43.94, that analysis suggests roughly 4% downside potential during the nearer term correction of the from February and about 25% during the correction of the rise from 2010 and that from 2009.

Good returns. The last upward wave of the{+1} lasted for 11 months, and so wave 1 {+1} that began June 19, if it is proportional, will provide a bias toward downward momentum into the summer of 2015.

Odds and Yields

This is the first bear signal since the June 19 peak. That peak, ending an uptrend that began in 2003 and whose most recent major leg up began in 2010, arguably wipes the slate clean insofar as odds analysis goes. The last major downtrend was six months at the end of 2008 and the beginning of 2009, far to long ago to say anything meaningful about the behavior of XLP in 2014.

The Fund

The list of XLP's top holdings is Procter & Gamble, at 12.75% of assets, followed by Coca-Cola, Philip Morris International, Wal-Mart Stores and CVS Caremark, each in the single digits but greater than 5%.

XLP's expense ratio is 0.16%, compared 0.09% for the most-traded exchange traded fund on the U.S. markets, SPY.

XLP's dividend yield is 2.52% annualized at today's prices, compared to 2.54% for 10-year U.S. Treasury notes.

The stock goes ex-dividend in September for a quarterly payout of 31.12 cents per share.

Liquidity and Volatility

XLP on average trades 8.2 million shares per day and supports a wide selectoin of option strike prices spaced a dollar apart, with open interest runing to three and four figures near the money.

The front-month at-the-money bid/ask spread on puts is 2.1%, compared to 0.3% for SPY.

Implied volatility stands at 13%, compared to 14% for the S&P 500, and has been rising since July 3. XLP's volatility is at the 29th percentile of the one-year range, suggesting that trades structured as long options spreads, bought with a debit, will have the best chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $42.34 and $45.72 over the next month, for a potential gain or loss of 3.9%, and between $43.22 and $44.84 over the next week. I've marked those levels on the left-hand chart in blue.

Contracts today are skewed heavily -- ridiculously so -- toward puts, which are running at 46 times their five-day average volume. Calls are running at 66% above their average.

Decision for My Account

I intend to open a bear position in XLP under my shorter-term rules. I'll make the trade today if downside momentum persists into the half hour before the closing bell. Otherwise, I'll put it on the Watchlist for later consideration.

-- Tim Bovee, Portland, Oregon, July 30, 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.

From time to time 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 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.