Wednesday, February 4, 2015

XLY: Bull play, shorter-term rules

Update 2/4/2015: XLY ended the day 37 cents below the Dec. 31 peak (see the chart discussion below). I've declined to take the trade and shall put the symbol on the Watchlist.

The Consumer Discretionary Select Sector SPDR Fund (XLY) broke above its 20-day price channel on Tuesday and traded still higher the next day, confirming the bull signal. [Disposable and discretionary income in Wikipedia]

The Chart

Click on chart to enlarge.
XLY 9 months daily bars
XLY has been on the rise since it hit rock bottom in 2009, the depths of the Great Recession. No rise is a straight line of course. XLY, like all traded entities, has traced a series of higher highs and high lows on its upward journey.

Elliott wave analysis shows that XLY hit its Dec. 31, 2014 peak of $72.97 after a five-wave rise. The ensuing correction under Elliott normally comes in three-wave sets.

Under the most straightforward count, the low of Jan. 16, $68.59, marks three waves down and the following rise is in the third of five waves, suggesting that there is considerable potential to the upside.

However, the entirely of waves A-B-C took only two weeks. In the preceding rise a single wave would take three weeks or more. So my count has a mismatch between timespans, suggesting that the waves after Dec. 31, 2014 are of a lower magnitude.

A beak above the Dec. 31 high will suggest that my count is indeed correct and wave 3 is rising to glory (and profit). A reversal to the downside short of $72.97 will suggest that a lower magnitude movement is complete and the downtrend has continued.

Odds and Yields

XLY has completed three bull breakouts in the past year. Two were successful, on average yielding 23.5% over 73 days. One was a failure, losing 12.5% over 13 days. The unsuccessful trade was the only upside breakout since the October 2014 low.

The Fund

The top four holdings, all with between 6% and 7% of weight, are DIS, AMZN, CMCSA and HD. A fifth, MCD, as a weight a bit above 4%. Altogether, XLY holds 86 symbols.

The expense ratio is 0.16%, compared to 0.09% for the most traded fund on the U.S. markets, the exchange-traded fund SPY, which tracks the S&P 500.

The dividend yield is 1.35% annualized at today's prices, compared to a 1.82% yield on 10-year U.S. Treasury notes.

XLY goes ex-dividend in March for a quarterly payout of 29.31 cents per share.

Liquidity and Volatility

XLY on average trades 8.6 million shares a day and supports a very wide selection of option strike prices spaced 50 cents apart. Open interest is spotty, with some near the money strikes having three and four figures and many having single digits or no open interest. This could make it tricky to construct a trade.

The front-month at-the-money bid/ask spread on calls is 5.0%, compared to 0.8% on SPY.

Implied volatility stands at 19%, about the same as the 18% for the S&P 500 index, and has been in a sideways trend since January. XLY's volatility is in the 57th percentile of its rise to its most recent high.

That level of volatility implies that the most profitable trades will be structured as shares or their synthetic equivalent.

Options are pricing in confidence that 68.2% of trades will fall between $68.74 and $76.64 over the next month, for a potential gain or loss of 5.4%, and that 95% will fall between $64.79 and $80.59.

Options are trading briskly today, with calls running 37% above their five-day average volume and puts at 46% above average.

Decision for My Account

The chart is ambiguous. I'm reluctant to open a bull position without a solid break above the wave 5 high of $72.97.

Moreover, the middlin' implied volatility relative to the prior rise is a negative. Shares are the preferred trade at that level, and they lack leverage.

I'll revisit the question if XLY breaks persistently above $72.97, but for now, I'm passing on the trade.

-- Tim Bovee, Portland, Oregon, Feb. 4, 2015


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.

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.

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