Dec 22, 2016 | educational newsletters, group and sector, jay kaeppel, stock market
In my last piece I note that the U.S. stock market presently stands alone in terms of recent performance. While virtually every major U.S. stock market average has run to new highs in the last several weeks, not one other individual country has really even come close. While this might induce spontaneous chants of “USA, USA”, the truth is that this may not necessarily be a good thing.
This current disconnect will likely be resolved in one of two ways:
A) The USA will drag the rest of the world screaming and kicking to enjoy in our newfound prosperity (assuming of course that we finally stumble upon that actual newfound prosperity that the stock market is telling us we should be celebrating).
B) The USA fails to pull up the rest of the world and the US stock market gets “dragged down” with the rest of the world’s bourses.
This is the part in the article where a skilled market analyst would offer up a clear and concise opinion of what will happen next and why. And if one happens to stop by the office in the next few minutes or so I will ask him or her what they think. All I know is that at the moment the US stock market is in an uptrend and that the majority of the rest of the world’s stock markets are fair to middling at best (with many looking much worse).
Until something changes I will stick to the US market, thank you very much.
A Little “Worldly” Perspective
What follows is essentially the world (stock markets) in pictures. The purpose is simply to provide you with some perspective regarding the state of the markets around the globe.
The key thing to note is:
*Figure 1 shows U.S. stocks making new highs
*Figures 2 through 6 show the rest of the world’s stock markets lagging far behind
Click Figures 1 through 6 to enlarge
Figure 1 – U.S. Stocks soaring to new highs (Courtesy
TradingExpert )
Figure 2 – My Own Index of Single Country ETFs; -17% below 2014 high (Courtesy
TradingExpert )
Editor’s note: information on creating your own index of ETFs or any other tickers in TradingExpert can be found here http://www.aiqsystems.com/Feb06%20OBM.pdf on page 5, titled Ability to Create Industry Groups for Your Special Trading Needs….
In Figures 3 through 6 note that the overall “stock market malaise” is not limited to one portion of our earth, but rather stretches pretty far East, West, North, South and pretty much all points in between.
Figure 3 – Middle East Stocks; -40% below 2007 high (Courtesy
TradingExpert )
Figure 4 – European Stocks; -36% below 2007 high (Courtesy
TradingExpert )
Figure 5 – Asia-Pacific Stocks;-17% below 2014 high (Courtesy
TradingExpert )
Figure 6 – North/South America Stocks; -22% below 2011 high (Courtesy
TradingExpert )
Wishing you (please choose any or all of the following that are applicable):
*Merry Christmas
*Happy New Year
*Happy Holidays
*Joy
*Peace on Earth
*[Some other phrase that you do not find offensive here]
Jay Kaeppel
Chief Market Analyst at JayOnTheMarkets.com and TradingExpert Pro client. http://jayonthemarkets.com/
Dec 21, 2016 | educational newsletters, ETFs, jay kaeppel, stock market
In this seemingly ever more divided and ever more electronic age, “perspective” is not a word (or action) that gets mentioned (or employed) with as much frequency as it used to. The default approach for a lot of things appears to be:
a) Decide ones opinion
b) Take to the internet to shout categorically that said opinion is the only possible “correct” opinion
c) Excoriate anyone who disagrees
Well, sure that is one approach. But when it comes to investing it is fairly important to raise one’s head and take a look around every once in awhile.
Hey, how about now?
The U.S. Stock Market Post Election
Since the election in November the U.S. stock market has been on a quite a tear, with the major market averages breaking out to new all-time highs as seen in Figure 1.
Figure 1 – Major market U.S. averages breakout to new highs (Courtesy
TradingExpert)
Now per a, b and c above, some will argue that this is a testament to the booming economy that #44 is leaving #45 while others will argue that it is a sign of new hope for the U.S. economy under a new adminstration.
My response: Whatever
Don’t get me wrong, I am all for a bull market. I hung in there all year despite a lot of doubts mostly because my trend-following indicators just kept staying bullish. And they remain thus. But like I said before a little perspective can sometimes go a long way.
A New (Republican) Administration
The historical fact is that the last 3 Republican administrations that followed Democratic administrations (Nixon, Reagan, Bush 43) did not experience great “stock market joy” during their first two years in office. Specifically, the first 21 months of the new four-year election cycle (i.e., starting on Dec. 31st of the election year through the end of September of the mid-term year) for each of these prior administrations witnessed a fair amount of “pain.”
Peruse Figures 2, 3 and 4 (which displays the % gain or loss for the Dow Jones Industrials Average for 21 months starting on December 31st of the election year) and see if you notice a trend.
Figure 2 – Dow % +(-); Dec-1968 thru Sep-1970 (Nixon – 1st 21 months)
Figure 3 – Dow % +(-); Dec-1980 thru Sep-1982 (Reagan – 1st 21 months)
Figure 4 – Dow % +(-); Dec-2000 thru Sep-2002 (Bush 43 – 1st 21 months)
The Good News is that there is no reason why this history has to repeat itself this time around. The Bad News is….that it very well could.
The Current Euphoria
As I stated earlier, when it comes to bull markets, I vote “YES”. I will take one anytime I can get it. And I also try to avoid being one of those “know it all types” (in the interest of full disclosure I am actually more one of those “sneaky” types who tries to intimate that he actually does know it all by trying not to act like a know it all – which is technically probably worse. But, hey, at least now you know) who routinely “talks down” a bull market (“Oh sure, things are great now but just you wait….” And so on). That “just you wait” stuff gets really old after a short while.
So here we stand. The major U.S. averages are bursting forth to new highs – so who am I to be a naysayer? Still, there is that pesky “perceptive” thing I mentioned earlier. Before getting too carried away with bullish euphoria please sear Figures 2, 3 and 4 above somewhere into the back of your brain – just in case.
Also note that the U.S. stock market is virtually alone in the world in terms of making new highs. Figure 5 displays:
Ticker VTI – Vanguard Total (U.S.) Stock Market ETF
Ticker VEU – Vanguard All World ex-U.S. Stock Market ETF
To be clear, ticker VTI essentially covers the entire U.S. stock market. Ticker VEU covers a broad array of major world stock markets BUT does not include U.S. stocks.
Figure 5 – U.S. Total Stock Market = New Highs; World Total Stock Market = NOT New Highs (Courtesy
TradingExpert)
Note that the U.S. market has broken out strongly to new highs while the “whole world” of markets is nowhere close to doing so. Certainly one can adopt the “What, me worry?” approach and argue that “the U.S. market will lead the other world markets to reach new highs.” And maybe that will prove to be the case.
But as I will highlight soon – and as reflected by tickers VTI and VEU – the U.S. stock market looks great while virtually the rest of the markets around the globe look pretty not so great. So please check back for Part II soon
In the meantime, enjoy the rally and the Holidays – I know I will.
Dec 8, 2016 | bonds, educational newsletters, ETFs, jay kaeppel, trading strategy
If you have read any of my stuff in the past then you probably know that I spend a lot of time trying to determine “what goes up (or down) when”. What follows are the results of one such test.
While the results are initially impressive on the face of it (if I do so say myself, and I think I just did) there are a number of important caveats. To put it another way, do NOT be impressed with the results WITHOUT first seriously considering some of the significant caveats mentioned below. To put it in the most standard terms possible – past results DO NOT guarantee future results.
The Test
*I looked at variety of assets classes (listed at the end of the article) using mutual fund data and/or index data from January 1993 through April 2007. The data was monthly total return data from Callan Associates.
*I’ve created my own proprietary formula for measuring performance during a specific month. The factors include: average monthly return, median monthly return, standard deviation, largest monthly decline and a variety of ratios amongst these factors (but I am a lot of fun at parties. No seriously.)
*I used my proprietary formula to rank performance for each asset class for each month and took my “top pick”. In a nutshell, the “top pick” is not the one that showed the largest average monthly gain but the one that showed the best tradeoff between risk and reward.
*I ran a backtest using mutual fund and/or index data for the top ranked asset for each month from January 1993 through May 2007. The results for Jay’s One Asset Class per Month strategy (heretofore JOAC) appear in Figure 1.
Figure 1 – Equity Curve for Jay’s One Asset Class per Month Strategy; 12/31/92-5/31/2007
The average 12-month return was +17.8% and the maximum drawdown (using month-end data) was -12.7%
While the results look good it is now time for those dreaded “caveats”:
*These results could not be exactly duplicated in real trading for a couple of reasons: First, some of the results were generated using index data and not mutual fund data.
*Also, many of the mutual funds used in the test (particularly Vanguard and Fidelity funds) cannot be traded one month at a time. Most have a minimum holding period of 30 to 90 calendar days). So buying in one month and selling out the next would likely result in fees and/or future trading restrictions.
Moving Forward JOAC using ETFs
ETFs have no switching restrictions so starting in May 2007 I switched to an all ETF portfolio, using a particular ETF each month to attempt to track the top asset class for that month. That portfolio appears in Figure 2.
Figure 2 – JOAC monthly ETF Portfolio
*-MUB traded in May 2007-2010; HYMB traded in May starting in 2011
Once again using monthly total return data from Callan Associates I tested the 2007-2016 period using the tickers listed in Figure 2. The results appear in Figure 3.
Figure 3 – Equity Curve for Jay’s One Asset Class per Month Strategy; 5/31/2007-10/31/2016
*The average annual gain starting in 2008 (the 1st full year of data) is +25.8%
*The maximum drawdown (using monthly data) is -11%.
Annual results in appear in Figure 4. These results do not include any transaction fees
Figure 4 – JOAC ETF Strategy Annual Results
*May 31st/2007-12/31/2007
So is this the greatest thing since sliced bread? Probably not. Why not? Time for more of those pesky caveats:
*Buying and holding only one ETF per month does not offer a lot of diversification (or any diversification at all for that matter)
*The test period using ETFs is relatively short
*Intramonth volatility and drawdowns will undoubtedly be greater than what appears in the Figures above
This strategy fits squarely in the “(almost certainly) high risk, (potentially) high reward” category.
Summary
So as I stated earlier, no one should assume that they can just start buying the ETFs listed above and start making 25% a year ad infinitum into the future. The results displayed in this article should probably be thought of more as a starting point for further analysis rather than a finished product.
In essence, the real point is that – as with all things – there is a time and a place or everything, including (apparently) asset classes.
Nov 11, 2016 | bonds, chart patterns, educational newsletters, ETFs, indexes, jay kaeppel
In real estate, it’s “Location, Location, Location.” In the financial markets it’s “the Trend, the Trend, the Trend.” There is a great deal of certainty about what will happen next in stocks, bonds and gold. But the key to successfully navigating these turbulent times starts not with predicting the future but rather with identifying the current trend in the here and now and going from there. So let’s take a look at, well, what else, the trends.
I have certain trend-following models that I follow to help me to determine which way to be leaning in the markets. Like any trend-following method they are far from perfect (my stock market model for example, suffered not one but two significant whipsaws in the last year+). But for me there is no expectation that they will be perfect. The only goal is to catch most of the upside during major bull markets, and miss much of the downside during major bear markets.
Stocks
For stocks I look at the 10-month and 21-month moving averages for the S&P 500 Index and use the following rules:
*A sell signal occurs when the S&P 500 closes 2 consecutive months below its 21-month moving average AND is also below its 10-month moving average
*Following a sell signal a new buy signal occurs when the S&P 500 registers a monthly close above its 10-month moving average
Figure 1 – Stock Market trend-following signals (Courtesy TradingExpert)
This method avoided much of the 1973-1974, 2000-2002 and 2008 bear market destruction. That’s the good news. The bad news is that it sold at the end of September 2015 and at the end of February 2016 – both just prior to powerful upside reversals (like I said, trend-following models ain’t perfect).
The most recent signal was a buy signal on 3/31/2016.
So the trend for stocks is presently BULLISH
Bonds
I have written several posts about this in the past. My favorite bond timing indicator is Japanese stocks. No seriously. They have a string tendency to trade inversely to the 30-yr US t-bond. I track ticker EWJ and watch the 5-week and 30-week moving averages. Because Japanese stocks and t-bonds trade inversely I use the following rules:
*A buy signal for bonds occurs when the 5-week moving average for EWJ drops below the 30-week moving average for EWJ
*A sell signal for bonds occurs when the 5-week moving average for EWJ rises above the 30-week moving average for EWJ
The most recent signal was a sell signal for t-bonds on 6/10/2016
So the trend for bonds is presently BEARISH
Figure 2 – Bond trend-following signals(Courtesy TradingExpert)
Gold
For gold I use two moving averages on a weekly chart for something I refer to as Jay’s Anti-Gold Index. Rather than go into a long explanation I will link to the
original article on the topic and offer a short explanation. In AIQ TradingExpert I created a ticker comprised of 4 other tickers (GLL, RYSDX, SPX and YCS) which all trade in a negatively correlated manner to the price of gold (er, usually).
One moving average I call the “FrontWeighted36DayMA” (“FrontWeightedMA” for short. The calculations are based on someone else’s work – unfortunately I cannot recall the person’s name so cannot give proper credit. Hopefully Karma will work and somewhere that person will Have a Nice Day without really knowing why. The calculations are a bit long-winded so the AIQ TradingExpert code appears at the end of this article.
The other is the 55-week exponential moving average.
(CAVEAT: Because some of these tickers did not exist until 2006 trading signals began on 12/31/1996, so yes, it is by my standards a relatively short test period for a long -term moving average method. To put it another way, don’t bet the ranch on gold basedon this one indicator)
The trading rules are as follows:
*When the FrontWeightedMA closes a week BELOW the 55-week MA then a BUY signal for gold occurs.
*When the FrontWeightedMA closes a week ABOVE the 55-week MA then a BUY signal for gold occurs.
Figure 3 – Gold Trading Signals (Courtesy TradingExpert)
The most recent signal was a buy signal on 3/18/16.
So the trend for gold is presently BULLISH.
Summary
These indicators represent “my opinion as to where the markets are headed next” (because the truth is I don’t know). There are objective, mechanical measures of where things stand today. Nothing more, nothing less.
Also, none these indicators falls into the “World Beater” or “You Can’t Lose in Investing” categories. But then again they are not really designed to (BTW if you do posses methods that do fit into either of the aforementioned categories, I would love to hear from you – off the record, of course). What they do achieve is to offer a decent frame of reference during times of doubt.
And that is one of the most powerful tools any investor can possess.
So in sum, the current trend (at least according to what you’ve seen here) for stocks and gold is bullish and the current trend for bonds is bearish.
How long any of these trends will remain in place is anyone’s guess. So enjoy them while they last.
Jay Kaeppel
Chief Market Analyst at JayOnTheMarkets.com
Oct 12, 2016 | expert rating, expert system, indexes, market timing
The AIQ TradingExpert Pro Market Timing Expert System uses over 400 rules based on numerous technical indicator conditions to determine if a change in the current trend is imminent. The signals can be quite early and confirmation from other indicators not used in the AI system, like Phase are recommended. Quick disclaimer, we are not advisors and do not give recommendations.
Here’s the signal from last week. The number of stocks with new highs vs new lows is clearly showing a persistent down trend, while the market has been flat.
By clicking the ER button in Charts we can see some of the major rules that have fired to generate the signal
The AIQ market Log in Reports provides additional information that gives us some broader information on the market. here we can see how a broad range of indicators on the market are fairing and also the percentage of buy vs sell signals on stocks in the S & P 500 (Unconfirmed signals 43-57, confirmed signals 33-67) .
The market action from Tuesday generated a second down signal of 2-98, following the 200 point fall in the Dow. The major rules that fired this time are below.
While never perfect, we always take heed when this many rules are firing
Sep 28, 2016 | educational newsletters, jay kaeppel, market timing
OK, I suppose I should refer to this as “my” best bear market strategy. For the record, “the” best bear market strategy is to sell short at the top and buy back at the bottom. Which reminds me, if you possess information on how to achieve this objective please feel free to pass your contact info on to me. Barring that, what follows is a pretty decent approach to dealing with bear markets.
Also, I will grant you that this is not the most “timely” article in the world, since we are not technically now in a bear market. Still it never hurts to “be prepared”, so I want to highlight one approach to trading a bear market.
First the bad news: this method involves a fair amount of trading – at least two trades a month to be specific. While this may not be everyone’s cup of tea, ultimately – using here the ubiquitous, annoying and yet highly appropriate phrase for our times – “It is what it is.”
- The Dow versus its 200-day moving average
- Specific trading days of the month
- Market Holidays
Dow versus 200-day moving average
For our purposes we will designate the stock market as being in a bear market when the Dow Jones Industrials Average is below its 200-day moving average. To sum it up as succinctly as possible:
Dow > 200-day moving average = GOOD
Dow < 200-day moving average = BAD
One important note: For trading purposes I use a one-day lag when a crossover occurs. If the Dow closes above the 200-day MA on Monday and then closes below it on Tuesday, then in theory the market turns bearish at the close on Tuesday. However, for actual trading purposes it is pretty tough to get a trade off at the close on Tuesday when you don’t know for sure that you should until…the close on Tuesday.
So for the record, for our purposes a “bearish” period begins at the close on the day afterthe Dow first closes below its 200-day moving average. Likewise, the bearish period ends at the close one trading day after the Dow closes back above its 200-day moving average.
When our 200-day moving average indicator above is “bearish” we designate the following trading days of the month as “bullish”
*The last 4 trading days of the month and the first 3 trading days of the next month
*Trading days #9, 10, 11 and 12
In other words, when the Dow is below its 200-day moving average we want to be long the stock market on these days
In addition to the trading days listed above, when our 200-day moving average indicator above is “bearish” we also want to be long the stock market on the 3 trading days before and the 3 trading days after each stock market holiday (New Years, Martin Luther King Day, President’s Day, etc.)
So what does all of this do for us? The results appear in Figure 1 below. To review, these results measure the growth of $1,000 invested in the Dow Jones Industrials Average only when:
*The Dow is below its 200-day moving average (with a 1-day lag following the crossover before a bearish period begins or ends)
*Today is within 3 trading days before or after a market holiday OR today is one of the last 4 trading days of the months, one of the first 3 trading days of the month or falls within trading days #9 through 12.
The blue line depicts the growth using Jay’s Bear Market Method. The red line depicts the growth from buying and holding the Dow Industrials Average while our 200-day moving average indicator is “bearish.”
Figure 1 – Growth of $1,000 invested in Dow using Jay’s Bear Market Method (blue line) versus $1,000 invested in Dow on all days when the Dow is below its 200-day moving average* (red line); 12/31/1938-9/26/2016
* – using a 1-day lag for crossovers
For the record, since 12/31/1938:
*$1,000 invested in the Dow only when the trend is “bearish” (i.e., below the 200-day moving average with a 1-day lag on crossovers) grew to $1,675 (or+67%)
*$1,000 invested in the Dow only when Jay’s Bear Market Method is bullish grew to $22,542 (or +2,154%). Now that’s what I call “making the best of a bad situation”.
Figure 2 displays the performance of the Dow during the “Worst of the Worst” trading days. In this scenario:
*The Dow is below its 200-day moving average (again with a 1-day lag for crossovers)
*Today is NOT one of the trading days of the month listed above and is NOT within 3 trading days of a market holiday.
Figure 2 – Growth of $1,000 invested in Dow when Dow is below 200-day moving average AND today is NOT one of the favorable trading days listed above; 12/31/1938-9/26/2016
For the record, $1,000 invested in the Dow ONLY on these “Worst of the Worst” trading days by -88% to $114 since 1938. Now that’s what I call a bear market.
Sep 19, 2016 | group and sector, indexes, stock market, Stock trading
The markets have been shall we say been less than inspiring recently. Brexit came and went with a brief hiccup in the action and only in the last week or so has the volatility picked up. The Dow as you can see in this weekly chart is back the same level as December 2014
The VXX shows clearly the decline in volatility since the high back in 2011
The summer doldrums may be over, but during periods when the market is range bound, segments within the market are often performing very well or very poorly. One AIQ Report that can show the strength within segments is the Relative Strength Strong – Short Term. This report shows stocks in 3 month trend up and is a great report for those who trade with ‘the trend is your friend’. Here is Friday 9-16-2016 report. The report is ranked by the stocks with the best trend.
I highlighted 6 stocks in the top of this report. All have good trends in place, and all in the Oil and Exploration S&P 500 group. The group has performed quite well recently. The top 2 OILEXPO stocks CHK and DVN have both had a small pullback to their uptrend line. We’ll see how they do this week.
Sep 2, 2016 | educational newsletters, ETFs, jay kaeppel, seasonal
Recently Jay Kaeppel of Jay On The Markets posted an update on the Seasonal Bonds Strategy using TMF. The gist of the strategy is straightforward, “Long TMF on the last 5 day of each month”
I’ve posted the article below.
Here’s a seasonal chart of the last 3 years with the average of the 3 years (black line). I colored the last 5 trading days of the average line in yellow to see what Jay was referring to. 8 of the 12 months were positive, 2 flat and 2 negative. Looks pretty good. At the bottom of the page you can see the returns this strategy yields.
BTW this Chart type, known as a seasonality chart will be included in the next AIQ TradingExpert Pro release this fall (OK marketing bit over)
So of course the bond market
rewarded my “brilliance” with a swift kick in the you know where in the months of March and April 2015 and especially in August 2015.
This would typically be enough to cause many people to go, “Well that guy’s and idiot” and to move on. But fortunately in this case, the market is a marathon and not a sprint.
Update
Figure 1 displays the results generated by:
*Holding long 1 t-bond futures contract ONLY for the last 5 days of each month since 12/30/1983
*Holding long 1 t-bond futures contract during all other days since 12/30/1983
Figure 1 – Long 1 t-bond futures contract ONLY during last 5 trading days of month (blue) versus long 1 t-bond futures contract on all other days (red); 12/31/1983-8/12/2016
The results sort of speak for themselves.
After I wrote about my aggressive TMF strategy, TMF (of course)
got hit very hard (as triple leveraged ETFs will do from time to time, hence the use of the words “aggressive” and “risky”), in March 2015 (-4.5%), April 2015 (-5.3%) and especially in August 2015 (-11.5%).
Still, as you can see in Figure 2, things have rebounded nicely since (hmmm, maybe I should be worried).
Figure 2– Growth of $1,000 Long ETF ticker TMF ONLY during last 5 trading days of month (blue) versus long TMF all other days; (red); 12/9/2009-8/12/2016
So far the “Long TMF on the last 5 day of each month” strategy is up +31.8% for the year in 2016.
| Year |
Last 5 TDM Long TMF |
| 2009* |
+12.9% |
| 2010 |
+33.4% |
| 2011 |
+15.2% |
| 2012 |
+35.7% |
| 2013 |
+6.7% |
| 2014 |
+45.7% |
| 2015 |
+6.8% |
| 2016** |
+31.8% |
*-Starting 4/16/2009 when TMF started trading
**-Through 8/12/2016
Summary
So did this odd little strategy “weather the storm” and “take the market’s best shot” in 2015 and now it is “smooth sailing”? Probably not. Make no mistake – this is a strategy that entails a great deal of risk. Still, for aggressive traders looking for an “edge”, it might be worth a closer look.
Jay Kaeppel
Aug 23, 2016 | educational newsletters, jay kaeppel, seasonal, trading strategy
Some days are just better than others – am I right or am I right? As a corollary, some days are worse than others. Wouldn’t it be nice to know in advance which days were going to be which?
Well, when it comes to the stock market, maybe you can.
The 3 Days to Miss
For our purposes we will refer to the very last trading day of the month as TDM -1. The day before that will be TDM -2, the one before that TDM -3, etc. Now let’s focus specifically on TDMs -7, -6 and -5.
Let’s now assume that we will buy and hold the Dow Jones Industrials Average every day of every month EXCEPT for those three days – i.e., we will sell at the close of TDM -8 every single month and buy back in 3 days later. We will refer to this as Jay’s -765 Method. Granted some may not be comfortable trading this often, but before dismissing the idea please consider the results.
Figure 1 displays the growth of $1,000 invested in the Dow as described above versus the growth of $1,000 from buying and holding the Dow.
*The starting date for this test is 12/1/1933.
*For this test no interest is assumed on the 3 days a month spent out of the market.
Figure 1 – Growth of $1,000 invested in Dow Industrials during all days EXCEPT TDM -7,TDM -6 and TDM -5 (blue line) versus $1,000 invested in Dow Industrials using buy-and-hold (red line); 12/1/1933-8/15/2016
For the record:
*Jay’s -765 Method gained +94,190%
*The Dow buy-and-hold gained +18,745%
While these results are compelling, the real “Wow” comes from looking at would have happened if you had been long the Dow ONLY on TDMs -7,-6 and -5 every month since 1933. These results appear in Figure 2 (but you’d better brace yourself before taking a glance).
Figure 2 – Growth of $1,000 invested in the Dow ONLY on the 7th to last, 6th to last and 5th to last trading days of every month since 12/1/1933
The net result is an almost unrelenting 83 year decline of -80%.
Summary
I would guess that some readers would like me to offer a detailed and logical reason as to why this works. Unfortunately, I will have to go with my stock answer of “It beats me.” Of course, as a proud graduate of “The School of Whatever Works” (Team Cheer: “Whatever!”) I am not as interested in the “Why” of things as I am the “How Much.”
Sorry, it’s just my nature.
Jay Kaeppel
Jul 29, 2016 | educational newsletters, ETFs, jay kaeppel, trading strategy
It pains me to say that I don’t know where the stock market is going next. You would think that after being in the markets for so long and following a bunch of indicators and systems etc., that by now I would have developed some ability to divine what is coming next.
Alas, I have not.
But I do know three things:
*My trend-following stuff is bullish so I need to give the bullish case the benefit of the doubt (no matter how nervous or cynical I may be).
*Based on a variety of indicators the market is certainly getting overbought
So, a thought today for those who might be wishing to hedge away some of their market risk.
Ticker TZA
Ticker TZA is not necessarily one of my favorites. It is an ETF that tracks 3 times the inverse of the Russell 2000 small-cap index. In other words, if ticker RUT falls 1% today then TZA should rise 3%. There are two primary concerns to keep in mind before considering buying shares of TZA are:
*The shares are extremely volatile
*The shares have experienced a serious downside bias – even when RUT is headed sideways (See Figure 1).
Figure 1 – Ticker TZA (black bars) versus Ticker RUT (Russell 2000) (Courtesy
AIQ TradingExpert)
So if you are going to buy TZA you’d better pick your spots. As I discussed here we are entering an “interesting” time for the market. So let’s explore the possibility of buying a call option on ticker TZA as a hedge against a potential market decline.
Call Option on TZA
Remember, TZA should increase in value if the Russell 2000 declines. Therefore, a call option on TZA should also increase in value if the Russell 2000 declines.
As you can see in Figure 2, the “implied volatility” (which generally tells you whether there is a lot of time premium built into the price of the options for a given security) for options on TZA is near the low end of the historical range. This tells us that there is relatively little time premium built into TZA options, therefore they are “cheap”.
Figure 2 – Implied option volatility for options on TA near the low end of the historical range (Courtesy
www.OptionsAnalysis.com)
Next I ran the “Percent to Double” routine in
www.OptionsAnalysis.com (see output in Figure 3. The phrase “percent to double” tells us what percentage the underlying stock must rise in order for the call option to double in price.
Figure 3 – Percent to Double routine suggests buying Sep30 TZA call which will double in price if TZA rises 12.56% (i.e., if RUT declines by roughly -4.19%) (Courtesy
www.OptionsAnalysis.com)
Figures 4 and 5 display the particulars and risk curves for buying 10 TZA Sep 30 calls.
A few things to note:
*The cost to buy 10 is $2,550.
*TZA is trading at $30.25/share.
*The breakeven price for this trade is $32.25 (if TZA is below $32.25 at expiration and we still hold this position then we will lose -$2,250)
*There are 50 days left until September expiration
*The trade has unlimited profit potential
Regarding potential, in Figure 6 we see that if TZA rallies back to its June low of $33.77 this trade will generate a profit of between $1,500 and $2,400 depending on how soon that price is reached
Summary
Is this a good trade? I can’t say for sure that it is. In fact, the only way this trade makes money is if the broader market suffers a hit, so a good part of me would prefer to see this trade “not work out”.
But the point of all of this is simply to point out that it is possible to hedge against a significant market decline by buying call options on an inverse leveraged ETF.
Mr. Market, you take it from here.
Jay Kaeppel
English