This week in From the Archives we present Chapter 4 in the Yates Guide to Options Investing (1994): The Missing Link -- Sector Analysis, written by Jim Yates.
When most investors think about portfolio management, they see a two-part problem. First, there's the market itself. Second, there are individual stocks. Portfolio managers know that there's a "missing link" between these two subjects. The missing ingredient is called sector analysis.
A sector is defined as "a distinguishable subdivision." From a stock-market point of view, a sector is a group of stocks in the same general industry. Because economic conditions increasingly affect entire industries, sector analysis has become an important part of portfolio management.
Sector analysis isn't an easy task. The job is similar to that of a portfolio manager in that stock selection is an important consideration. Determining the appropriate sector designation for a stock is not always simple because a company may have operations in several different industries. In addition, a decision must be made as to how many distinguishable subdivisions there are in the market. Finally, there's the problem of comparing the performance of sectors. Wile all of the above is going on, it must be remembered that the purpose is to remain objective in the analysis.
The Zone system of stock market analysis is particularly suited to sector evaluation because it allows the objective measurement of the relative movement of often widely varying groups of stocks.
Our sector analysis divides the market into 20 industry groups. These groups were chosen because we wanted to keep the list to a manageable number, and 20 seemed the logical choice. Each stock in our database is assigned to one of the 20 groups on the basis of its major business activity. The 20 sectors are:
-- Aerospace -- Autos -- Building --Chemical --Consumer
-- Data Processing --Drugs --Electronics --Food --Insurance/Finance
--Integrated Oils --Leisure --Machinery --Metals --Miscellaneous (Conglomerates)
--Non-Integrated Oils --Oil Service --Retail Trade --Transportation --Utilities
The ranking score for each sector is determined by averaging the 90-day Implied Risk readings for all the issues in the group. The Implied Risk reading for each stock represents the percentage deviation of the price of the stock from its 90-day trend, relative to what is expected given the stock's option implied volatility.
A stock with an Implied Risk reading of -100 is at the top of its Implied Risk trading range. When stocks are grouped together as they are in this analysis, there's a dampening effect to the average Implied Risk score. This dampening is called the "portfolio effect," and is due to the fact that stocks in a portfolio -- even those is similar industries -- rarely move at exactly the same time. We adjust for the portfolio effect by reducing the group range from +60 to -60.
We rank the 20 groups, with the group nearest the top of its Implied Risk trading range ranked first. We also list the Implied Risk score for each sector over the past week, month and three months. The objective isn't only to determine the strongest sector in the market, but also to determine the probability of future advances. The recent sector scores are intended to provide trend perspective that allows us to identify groups that are making significant moves relative to the rest of the universe.
The sector score range of +60 to -60 means there are six 20-point divisions, which we call Zones. An industry group with an Implied Risk reading above -40 as reached Zone 6. To get to Zone 1, a group needs to compile an Implied Risk reading below +40. The expectation of occurrences in each Zone is the same as for individual issues. We expect each sector to visit each Zone annually, and we expect them to be in Zone 3 or Zone 4 about two-thirds of the time.
The purpose of this type of analysis is to fill in that gap between market-risk analysis and stock-risk analysis. We believe that market risk represents about 50% of the total risk involved in trading stocks. Stock risk represents another 25% of your total risk. That leaves 25% of the total risk for the sector analysis. Proper sector analysis, we believe, can improve both stock-market analysis and and individual-issue analysis.
In the case of the general market, a close study of the sector can often explain otherwise inexplicable market activity. A rising market may be led by the Integrated Oils, for example. That sends a different message than an advance led by Insurance & Finance. Individual stocks analysis also can be enhanced using sector analysis. For instance, a stock that reaches either extreme (Zone 1 or Zone 6) while its sector is at the opposite end of the spectrum could be experiencing an important fundamental change. The stock that resists sector weakness may signal future strength.
This latter factor is similar to a condition technicians often refer to as relative strength. But this kind of relative strength is different, because it relates individual stock movement to the sector rather than to the overall market. Because sector analysis enhances our understanding of both the overall market and of specific stocks, it deserves the title Missing Link.
This system allows us to measure movement relative to expectations. For instance, technology stocks may experience a larger percentage move than other issues, but that greater movement potential is anticipated and incorporated into the volatility estimates for individual issues in the sector. When we adjust the movement for volatility expectations, we're left with a uniform analysis that permits direct comparison of wildly disparate sectors and issues.
Friday, August 17, 2007
Shades of '29
The Fed cut the discount rate this morning, but why? How is a 1/2-point reduction in the rate that banks pay for overnight loans going to help? You think it's time to borrow some money and take some risk? Anyone want to buy a second home as speculation?
The government has repeated the mistakes it made back in '29. This time, they didn't break off credit to stock owners -- they did it to home buyers. If you had any idea what was happening in the condo conversion market the past couple years, you could see we were headed for trouble. There are some many headaches with owning a 20-year old apartment, who would want to do it? Resell value sucks, and good luck fixing the aging structure that houses your apartment. You'll never get your co-owners to agree. And it's going to cost you.
Back to the government. They allowed the creation of these sub-prime brokers -- barely at arms' length from the banks that supported them with credit lines to fund their mortgage pools -- and then allowed them to be shut down. They created a market, then closed it to secondary offerings. Now all these people are stuck with homes and condos for which there is no secondary market. Clearly, they should have created a government entity designed to offer support packages to these stupid buyers. Not for them, but for us.
The Fed seems eager to pump money into the market, but that extra cash is going to the sellers, not the buyers. The banks already made their money on these entities; they shouldn't get more. The government should take all this money their giving the banks to lend and set up an agency to lend only to people who will take a property with a sub-prime loan attached and turn it into a property with a prime-rate loan attached. Of course, that means a serious decline in home prices, because the property will be worth less to a prime-rate borrower than s sub-prime borrower. But it would put a floor on losses we're about to realize in the home market.
Too late. The made credit available, then they cut it off. Guess nobody's around still from '29.
The government has repeated the mistakes it made back in '29. This time, they didn't break off credit to stock owners -- they did it to home buyers. If you had any idea what was happening in the condo conversion market the past couple years, you could see we were headed for trouble. There are some many headaches with owning a 20-year old apartment, who would want to do it? Resell value sucks, and good luck fixing the aging structure that houses your apartment. You'll never get your co-owners to agree. And it's going to cost you.
Back to the government. They allowed the creation of these sub-prime brokers -- barely at arms' length from the banks that supported them with credit lines to fund their mortgage pools -- and then allowed them to be shut down. They created a market, then closed it to secondary offerings. Now all these people are stuck with homes and condos for which there is no secondary market. Clearly, they should have created a government entity designed to offer support packages to these stupid buyers. Not for them, but for us.
The Fed seems eager to pump money into the market, but that extra cash is going to the sellers, not the buyers. The banks already made their money on these entities; they shouldn't get more. The government should take all this money their giving the banks to lend and set up an agency to lend only to people who will take a property with a sub-prime loan attached and turn it into a property with a prime-rate loan attached. Of course, that means a serious decline in home prices, because the property will be worth less to a prime-rate borrower than s sub-prime borrower. But it would put a floor on losses we're about to realize in the home market.
Too late. The made credit available, then they cut it off. Guess nobody's around still from '29.
Thursday, August 16, 2007
Told You So
You gotta love the Merrill analyst who took Countrywide (CFC) to a sell from a buy he issued two days earlier. Hopefully the psychological scars he absorbs from becoming an industry laughingstock will last until the end of his days. Can you say boiler room?
We've been harping since May about the bad prospects for the market in August. Here's what we said about the market in May, June and July:
May 7 -- "We'd guess that most of the gains for this year have already been made. The rest of '07 will be about holding those gains."
May 14 --"This rally is bad for the economy. The groups that are strongest -- commodities, cyclicals and defense -- are the ones killing the country. When all is said and done -- we'd say about August -- it'll be bad."
May 21 -- "We'd stay away from the weakest group in our rankings, though. REITs have been crushed, but we suspect there's more to come. In fact, we'd short Housing (HCX) again while it's around 90-day neutral. When we finally do make it back to Zone 1 this year, we think the housing stocks will be the downside leaders. REITs too."
May 29 -- "Hope you made some money the the last couple months. The next couple months should be a time to reduce your positions heading into August."
June 4 -- "Broker/Dealer (XBD) is one of the strongest sectors again. All is well with the market. We'd get out now. Sell in May and go away sounds about right...In three months or so, the bonds will be near Zone 6 and yields will be weak...We don't believe the economy warrants such an impressive run. It's all about liquidity...There is lots of risk in this market. We're looking for a Zone 1 reading in late August or early September, when the market usually has its worst days. Then we'll talk about buying."
June 11 -- "The Fed says it won't lower interest rates, but the market rallies anyway...This market doesn't want to die yet. Wait until August...We expect bonds to be overbought and yields to be oversold by summer's end."
June 18 -- "Stronger bonds had the stock market on a strange rebound last week. It's strange because most indexes and sectors are near Zone 6. There is so much liquidity that pullbacks don't even reach 90-day neutral. Overall, the market's action doesn't match the data. We don't like it."
June 25 -- "We're halfway through the trading year, and we may have seen the market highs for '07...The true repercussions from the housing bubble are starting to be reflected in the financial markets. And the market is coming off a nice Zone 6 reading. It'll be a long summer..We don't see how banks can get out from under the mortgage mess until some losses are taken."
July 2 -- "The Fed didn't clear things up much last week. Looks like they wouldn't mind if the stock market cooled...The sub-prime mortgage fiasco isn't going away. In fact, it'll get worse. Bank and housing indexes have dipped into Zone 2. They should lead the rest of the market down."
July 9 -- "The DYR Phase Chart has bounced back up to -21 in Zone 5...We still think the new trend is down toward 90-day neutral. A sideways market this month, or a quick drop soon, would get us there. Then we'll see what happens in August and September."
July 16 -- "Did good retail numbers really send the Dow Jones Industrial Average (DJIA) up 250 points in one day? But didn't Home Depot (HD) and Sears (SHLD) warn? Looks to us like there's a bunch of people spending a bunch of other people's money on risky stocks...We're just waiting for Broker/Dealer (XBD) to start leading the market south...Consumer (CMR) and Retail (MVR) are among the weaker sector indexes on a 90-day basis. We wouldn't be surprised to see these indexes lead the fall as we get into August and September."
July 23 -- Headline: Time For Puts. "Broker/Dealer (XBD) has broken down...We think the market follows the brokers. That means it's time to buy puts on the market and certain sectors...As far as strategy goes, look at puts on the stronger indexes (SOX, QQQQ), foreign ETFs (XEX, CZH) and financials (XBD, RKH)...time to take profits on Gold/Silver (XAU). The index is in Zone 6, just barely, over both 90-days and 10-days. It's hard to see the dollar falling lower. If the market tanks, golds will fall too."
July 30 -- "There's another one or two standard deviations to fall before we call it a wipeout. Our last Zone 1 reading: March '03."
We've been harping since May about the bad prospects for the market in August. Here's what we said about the market in May, June and July:
May 7 -- "We'd guess that most of the gains for this year have already been made. The rest of '07 will be about holding those gains."
May 14 --"This rally is bad for the economy. The groups that are strongest -- commodities, cyclicals and defense -- are the ones killing the country. When all is said and done -- we'd say about August -- it'll be bad."
May 21 -- "We'd stay away from the weakest group in our rankings, though. REITs have been crushed, but we suspect there's more to come. In fact, we'd short Housing (HCX) again while it's around 90-day neutral. When we finally do make it back to Zone 1 this year, we think the housing stocks will be the downside leaders. REITs too."
May 29 -- "Hope you made some money the the last couple months. The next couple months should be a time to reduce your positions heading into August."
June 4 -- "Broker/Dealer (XBD) is one of the strongest sectors again. All is well with the market. We'd get out now. Sell in May and go away sounds about right...In three months or so, the bonds will be near Zone 6 and yields will be weak...We don't believe the economy warrants such an impressive run. It's all about liquidity...There is lots of risk in this market. We're looking for a Zone 1 reading in late August or early September, when the market usually has its worst days. Then we'll talk about buying."
June 11 -- "The Fed says it won't lower interest rates, but the market rallies anyway...This market doesn't want to die yet. Wait until August...We expect bonds to be overbought and yields to be oversold by summer's end."
June 18 -- "Stronger bonds had the stock market on a strange rebound last week. It's strange because most indexes and sectors are near Zone 6. There is so much liquidity that pullbacks don't even reach 90-day neutral. Overall, the market's action doesn't match the data. We don't like it."
June 25 -- "We're halfway through the trading year, and we may have seen the market highs for '07...The true repercussions from the housing bubble are starting to be reflected in the financial markets. And the market is coming off a nice Zone 6 reading. It'll be a long summer..We don't see how banks can get out from under the mortgage mess until some losses are taken."
July 2 -- "The Fed didn't clear things up much last week. Looks like they wouldn't mind if the stock market cooled...The sub-prime mortgage fiasco isn't going away. In fact, it'll get worse. Bank and housing indexes have dipped into Zone 2. They should lead the rest of the market down."
July 9 -- "The DYR Phase Chart has bounced back up to -21 in Zone 5...We still think the new trend is down toward 90-day neutral. A sideways market this month, or a quick drop soon, would get us there. Then we'll see what happens in August and September."
July 16 -- "Did good retail numbers really send the Dow Jones Industrial Average (DJIA) up 250 points in one day? But didn't Home Depot (HD) and Sears (SHLD) warn? Looks to us like there's a bunch of people spending a bunch of other people's money on risky stocks...We're just waiting for Broker/Dealer (XBD) to start leading the market south...Consumer (CMR) and Retail (MVR) are among the weaker sector indexes on a 90-day basis. We wouldn't be surprised to see these indexes lead the fall as we get into August and September."
July 23 -- Headline: Time For Puts. "Broker/Dealer (XBD) has broken down...We think the market follows the brokers. That means it's time to buy puts on the market and certain sectors...As far as strategy goes, look at puts on the stronger indexes (SOX, QQQQ), foreign ETFs (XEX, CZH) and financials (XBD, RKH)...time to take profits on Gold/Silver (XAU). The index is in Zone 6, just barely, over both 90-days and 10-days. It's hard to see the dollar falling lower. If the market tanks, golds will fall too."
July 30 -- "There's another one or two standard deviations to fall before we call it a wipeout. Our last Zone 1 reading: March '03."
Wednesday, August 15, 2007
From the Archives: The Straddle -- Key to Understanding the Listed Options Market
On Wednesdays, we re-publish columns written by the inventor of Implied Risk, Jim Yates. Today's article in From the Archives was originally published on April 25, 1988.
Prior to the creation of the listed option market in 1973, most writers sold straddles. A straddle consists of a put and a call on the same stock with the same expiration and exercise price. The number of option writers was small, as was the entire options business. Straddle writers were the financiers of the business. They invested their capital in low-risk positions, usually municipal bonds, and agreed to buy or sell a stock at a price for the put and call premium.
When the listed options market began, straddle writing was not possible in the same way it had been in the old market. The new market was calls only. It was possible to establish a ratio-write position by buying 100 shares of stock and selling two at-the-money calls. This position was the equivalent of a straddle but because it required that the old underlying capital be invested in the stock, most of the old writers were not very interested. In addition, the new market offered much lower premiums, which suggested lower returns. This, among other reasons, led the old pros of the business to conclude that the new market had little chance of success.
The most important development leading to the establishment of the new market was the Black-Scholes option pricing model. The model determined the value of an option by calculating the premium needed to exactly neutralize a stock position and return the risk-free rate. Initially the market was calls only, but by 1980 calls and puts were traded on all stocks. With both puts and calls trading, it was now possible to establish straddles in the listed options market.
A straddle is an example of neutral risk position. The new model determined the fair value of such a position, which meant its goal was to determine the value for the position that would not yield an advantage to the writer or buyer. Naturally, writers who were accustomed to high returns for risking their capital were not happy. The most important factor in the model was the volatility assumption. If the volatility assumed was too high, the premium value would be excessive and writers would earn an excess return. If the assumption was too low, the buyers benefited. As the market grew over the past 15 years, the ability of the market to adjust to changes has steadily improved.
Straddle writing in the listed option market has had its good years and its bad years. The late 70's were good years. 1980 was a bad year, as have been the past two years. One factor that has led to big troubles for writers has been the ability to leverage positions. Under current margin requirements, it is possible to leverage straddle writing on individual stocks by a factor of 5 to 1. In the index options market, this number, until recently, was 20 to 1. The result was that the negative periods which appear as relatively small moves were in fact huge if the position was fully leveraged.
The strategy has performed as designed. The beta factor for a T-bill straddle portfolio should be close to zero if it is in fact a neutral strategy. The numbers for both the last five years and since the start of listed options trading confirm this assumption. As the market has grown, the profitability of the strategy has declined. This leads us to conclude that the option market is becoming better at its job of handicapping the market; in other words, it is becoming increasingly efficient.
While an efficient listed option market is bad news for those seeking a free lunch from option writing, it may be good news for those looking to the option market for information. An efficient market means that the market has good handle on expected volatility. That means that the implied volatility that can be determined from prices in the option market are becoming more accurate. It has often been noted that "if you can't beat 'em, join 'em." Since it is hard to beat such an efficient market, it may be a good time to observe the market and study its tendencies.
A straddle is essentially an expression of the price distribution expectations for the underlying stock or index. A straddle with a large premium value indicates a stock with a wide price-band expectation. The volatility assumption may allow us to determine exactly how much the price of a stock may deviate from its longer trend under normal conditions. That concept is the basis for the data in our reports. The Option Phase Chart was initially tested by determining the equivalent market position of a continuously managed straddle portfolio. The scale of scale of the Option Phase Chart comes from the expected range of observations for the account. It is expected that the account will vary from a maximum equivalent long position of 50% to a maximum short position of 50%. Most of our observations should be in the +/- 20% area.
Prior to the creation of the listed option market in 1973, most writers sold straddles. A straddle consists of a put and a call on the same stock with the same expiration and exercise price. The number of option writers was small, as was the entire options business. Straddle writers were the financiers of the business. They invested their capital in low-risk positions, usually municipal bonds, and agreed to buy or sell a stock at a price for the put and call premium.
When the listed options market began, straddle writing was not possible in the same way it had been in the old market. The new market was calls only. It was possible to establish a ratio-write position by buying 100 shares of stock and selling two at-the-money calls. This position was the equivalent of a straddle but because it required that the old underlying capital be invested in the stock, most of the old writers were not very interested. In addition, the new market offered much lower premiums, which suggested lower returns. This, among other reasons, led the old pros of the business to conclude that the new market had little chance of success.
The most important development leading to the establishment of the new market was the Black-Scholes option pricing model. The model determined the value of an option by calculating the premium needed to exactly neutralize a stock position and return the risk-free rate. Initially the market was calls only, but by 1980 calls and puts were traded on all stocks. With both puts and calls trading, it was now possible to establish straddles in the listed options market.
A straddle is an example of neutral risk position. The new model determined the fair value of such a position, which meant its goal was to determine the value for the position that would not yield an advantage to the writer or buyer. Naturally, writers who were accustomed to high returns for risking their capital were not happy. The most important factor in the model was the volatility assumption. If the volatility assumed was too high, the premium value would be excessive and writers would earn an excess return. If the assumption was too low, the buyers benefited. As the market grew over the past 15 years, the ability of the market to adjust to changes has steadily improved.
Straddle writing in the listed option market has had its good years and its bad years. The late 70's were good years. 1980 was a bad year, as have been the past two years. One factor that has led to big troubles for writers has been the ability to leverage positions. Under current margin requirements, it is possible to leverage straddle writing on individual stocks by a factor of 5 to 1. In the index options market, this number, until recently, was 20 to 1. The result was that the negative periods which appear as relatively small moves were in fact huge if the position was fully leveraged.
The strategy has performed as designed. The beta factor for a T-bill straddle portfolio should be close to zero if it is in fact a neutral strategy. The numbers for both the last five years and since the start of listed options trading confirm this assumption. As the market has grown, the profitability of the strategy has declined. This leads us to conclude that the option market is becoming better at its job of handicapping the market; in other words, it is becoming increasingly efficient.
While an efficient listed option market is bad news for those seeking a free lunch from option writing, it may be good news for those looking to the option market for information. An efficient market means that the market has good handle on expected volatility. That means that the implied volatility that can be determined from prices in the option market are becoming more accurate. It has often been noted that "if you can't beat 'em, join 'em." Since it is hard to beat such an efficient market, it may be a good time to observe the market and study its tendencies.
A straddle is essentially an expression of the price distribution expectations for the underlying stock or index. A straddle with a large premium value indicates a stock with a wide price-band expectation. The volatility assumption may allow us to determine exactly how much the price of a stock may deviate from its longer trend under normal conditions. That concept is the basis for the data in our reports. The Option Phase Chart was initially tested by determining the equivalent market position of a continuously managed straddle portfolio. The scale of scale of the Option Phase Chart comes from the expected range of observations for the account. It is expected that the account will vary from a maximum equivalent long position of 50% to a maximum short position of 50%. Most of our observations should be in the +/- 20% area.
Tuesday, August 14, 2007
Options Tuesday: Selling Cash-Secured Puts
Now that option implied volatility has soared, we can talk about selling puts. Not naked puts, but cash-secured puts. You cash-secure your puts by putting aside the cash you would have to pay to buy the stock, if you got assigned your short puts. 50% of the stock price, true margin, will do. You can put the cash in a money market fund that's accessible, but you must carve that cash out of your money pile and set it aside.
Cash-securing your puts keeps the focus on trading stocks, rather than trading options. Your profit/loss is calculated against the total investment of 50%-margined stock minus the income you receive from selling puts. When you think about it, it's the same as a buy/write, except all your potential profit is in the option rather than in a combination of stock and option profit in the buy/write.
In fact, the profit/loss graph of the cash-secured put is the same as the buy/write of the same issue and strike. Now, which stocks would you commit to a buy/write now? We like to look for extremely oversold sectors that haven't been the focus of the downturn. We like the retail stocks -- which have been hurt as bad as the broker/dealers -- as buy/writes or cash-secured short puts.
Looking ahead, we have Thanksgiving and Christmas to surprise on the upside. Once the market gets rallying in the fourth quarter, people will start spending again. Right now, Morgan-Stanley Retail (MVR) is at the bottom of Zone 1 on a 90-day basis, and at the top of Zone 1 on a 10-day basis. It may go lower this week, considering the momentum. But it's OK to start establishing buy/writes or selling cash-secured puts.
Here's the trick to selling puts: You need to allow enough time for the issue to recover, but you don't want to have to wait too long to make your nut. Two or three months is about right. One month isn't enough time for the oversold issue to recover. Four months means your premium doesn't start wasting away for 12 weeks or so. Say the issue is unchanged for one year -- you would make more money selling four three-month options than you would selling three four-month options.
We like selling three-month options, particularly once the market's found a bottom. That means November or December expiration. We still think this will end in a gigantic blow-off selling day, maybe to include a violent upside reversal. Maybe the blow-off will cover a few days. We'll know it when we see it. We're looking for it.
Cash-securing your puts keeps the focus on trading stocks, rather than trading options. Your profit/loss is calculated against the total investment of 50%-margined stock minus the income you receive from selling puts. When you think about it, it's the same as a buy/write, except all your potential profit is in the option rather than in a combination of stock and option profit in the buy/write.
In fact, the profit/loss graph of the cash-secured put is the same as the buy/write of the same issue and strike. Now, which stocks would you commit to a buy/write now? We like to look for extremely oversold sectors that haven't been the focus of the downturn. We like the retail stocks -- which have been hurt as bad as the broker/dealers -- as buy/writes or cash-secured short puts.
Looking ahead, we have Thanksgiving and Christmas to surprise on the upside. Once the market gets rallying in the fourth quarter, people will start spending again. Right now, Morgan-Stanley Retail (MVR) is at the bottom of Zone 1 on a 90-day basis, and at the top of Zone 1 on a 10-day basis. It may go lower this week, considering the momentum. But it's OK to start establishing buy/writes or selling cash-secured puts.
Here's the trick to selling puts: You need to allow enough time for the issue to recover, but you don't want to have to wait too long to make your nut. Two or three months is about right. One month isn't enough time for the oversold issue to recover. Four months means your premium doesn't start wasting away for 12 weeks or so. Say the issue is unchanged for one year -- you would make more money selling four three-month options than you would selling three four-month options.
We like selling three-month options, particularly once the market's found a bottom. That means November or December expiration. We still think this will end in a gigantic blow-off selling day, maybe to include a violent upside reversal. Maybe the blow-off will cover a few days. We'll know it when we see it. We're looking for it.
Sunday, August 12, 2007
A Steel Steal
We wrote about the opportunity to make money on steel-stock puts about two months ago. While the Steele (STQ) index has pulled back about 10%, there is a lot of excess ready to be squeezed out. All these stocks were juiced up as investors were led to believe the world expansion would continue for ever. Well, the money spigot just got cut off.
Here's what we wrote back on June 18:
"Here’s how crazy things have gotten. Posco (PKX), the fourth largest steel maker in the world, plans to expand its output next year by 30%. The company says it has orders for steel plates from shipbuilders. Things is, both PKX and the four largest shipbuilders are based in South Korea. Can you say corruption? Lots of risk here.
PKX, like the rest of the steels, has doubled over the past year. The stock remains more than 100% overbought on a 90-day basis, about the same as Steel Producers (STQ). We’re no economists, but shouldn’t the tightening of credit worldwide hurt these guys? Implied volatility (IV) expectations for steel stocks are among the lowest in the business, which makes long-term puts relatively cheap."
Since we wrote that, PKX rose to peak at nearly 155 before pulling back to close Friday at 133.95. The stock is still in Zone 3 on a 90-day basis, about one-half standard deviation above its mean price. That leaves another couple standard deviations to fall, at least.
Right now, STQ is among the weakest sector indexes we follow. Just a few months ago, it was among the strongest. (Ditto goes for Coal Producers (SCP), which rushed to all-time highs for the same reasons.) If we can get a rally from these indexes, we'll short the group again. We might have to wait until the end of the year, but maybe not.
Here's what we wrote back on June 18:
"Here’s how crazy things have gotten. Posco (PKX), the fourth largest steel maker in the world, plans to expand its output next year by 30%. The company says it has orders for steel plates from shipbuilders. Things is, both PKX and the four largest shipbuilders are based in South Korea. Can you say corruption? Lots of risk here.
PKX, like the rest of the steels, has doubled over the past year. The stock remains more than 100% overbought on a 90-day basis, about the same as Steel Producers (STQ). We’re no economists, but shouldn’t the tightening of credit worldwide hurt these guys? Implied volatility (IV) expectations for steel stocks are among the lowest in the business, which makes long-term puts relatively cheap."
Since we wrote that, PKX rose to peak at nearly 155 before pulling back to close Friday at 133.95. The stock is still in Zone 3 on a 90-day basis, about one-half standard deviation above its mean price. That leaves another couple standard deviations to fall, at least.
Right now, STQ is among the weakest sector indexes we follow. Just a few months ago, it was among the strongest. (Ditto goes for Coal Producers (SCP), which rushed to all-time highs for the same reasons.) If we can get a rally from these indexes, we'll short the group again. We might have to wait until the end of the year, but maybe not.
Thursday, August 9, 2007
The Shakeout Begins
On a day when the markets got whacked, homebuilders, regional banks and REITs were strong on a relative basis. Techs and the oils were the hardest hit on Thursday. That tells you they were dumping high beta issues. Sure sounds like fund liquidation to us. We also don't think those financials got whacked quite enough. If they get sent to the bottom of our short-term index rankings again -- and they make Zone 1 -- we think it'll be time to buy the financials. Then watch out, because the roar upward is going to be almost as breath-taking as the plunge down. This is what it takes to shake all these extra hedge funds out of the market.
We think Friday has the potential to be the largest down day in history, point-wise. The funds don't want to hear the news that comes out over the weekend, so it could look like a general-admission Who concert as money managers stampede out the door. Very few sectors are wiped out now, but we'll have to see after Friday. There is plenty of room to fall. Expected trading ranges have expanded (via implied volatility expansion) as the market has retreated. At these inflated range expectations, most of the broad-based indexes are around one standard deviation below their 90-day means.
Funny article in Marketwatch.com on about how a bunch of market neutral funds are having difficulty surviving the downturn. No explanations were offered as to why the profits on these funds shorts didn't cover the losses on their longs. You gotta wonder which part of market-neutral these guys didn't understand. Yet the guy who spoke for the article, a market-neutral fund manager who supposedly had $1.9 billion long and $1.9 billion short, is down 10% this month. He says it's happening to all market-neutral funds. Yeah, sure.
We think Friday has the potential to be the largest down day in history, point-wise. The funds don't want to hear the news that comes out over the weekend, so it could look like a general-admission Who concert as money managers stampede out the door. Very few sectors are wiped out now, but we'll have to see after Friday. There is plenty of room to fall. Expected trading ranges have expanded (via implied volatility expansion) as the market has retreated. At these inflated range expectations, most of the broad-based indexes are around one standard deviation below their 90-day means.
Funny article in Marketwatch.com on about how a bunch of market neutral funds are having difficulty surviving the downturn. No explanations were offered as to why the profits on these funds shorts didn't cover the losses on their longs. You gotta wonder which part of market-neutral these guys didn't understand. Yet the guy who spoke for the article, a market-neutral fund manager who supposedly had $1.9 billion long and $1.9 billion short, is down 10% this month. He says it's happening to all market-neutral funds. Yeah, sure.
Wednesday, August 8, 2007
From the Archives: The Zone System
Each Wednesday we'll reach back into our 25-year archive of commentary by our founder, Jim Yates. Here's an excerpt from 1994's The Yates Guide to Profitable Options Investing:
The Zone system is based on an analysis of the deviation of a stock's price from it's trend. Zones are the six areas under a normal bell-shaped curve defined by standard deviations. Zone 1 represents the area that is between two and three standard deviations below the mean. Zone 6 is at the other extreme. Zones 1 and 6 are the farthest points from a stock's mean, or where it has historically migrated during reversion to the mean. The mean is the vertical line bisecting the normal curve and it's called the trend.
Because it's future distribution we're concerned about, the implied volatility for the stock is used to estimate that standard deviation. Implied volatility is the annualized standard deviation that justifies the current options price. This is a particularly important statistic because it's the only market-derivable statistic that represents a forecast of future price movements.
We use two time frames for analysis, 10 days and 90 days. There's nothing magical about these two time frames, they were chosen because they fit the profile of a short-term trader and options hedger.
In the process of the evaluation, each Zone is expanded to a 33-point scale. A stock that is at the three standard deviation limit, or Zones 1 and 6, could then be said to be either 99% oversold (Zone 1) or 99% overbought (Zone 6).
The beauty of the Zone system is that it's easy to use. By simply identifying which Zone a stock's in, you can formulate a strategy. Next week we'll describe a tool we've named the Options Strategy Spectrum. The similarity between the Options Strategy Spectrum and the normal distribution curve is no coincidence. They're the same, but we've broken down the bell curve into Zones that delineate which stock-and-options strategy is appropriate at the time. Zones 1, 2 and 3 are below the mean (or oversold), while Zones 4,5 and 6 are above the mean (or overbought).
The Zone system is simply another way of looking at the market, but from a risk perspective. One advantage of the system is that it allows direct comparison of the overall market, market sectors and individual stocks at the same time. Every market index, sector index and individual issue will visit each Zone over the course of time. When issues move to the extreme Zones, the probability is high that the next move will be back toward the mean, assuming the volatility estimate delivered by the market proves reliable.
The Zone system can be compared to a map. While a map may be of significant benefit in determining where you are headed, it's most important contribution is detailing where you are right now. If you don't know your current location, it's nearly impossible to locate the path to your desired destination.
The Zone system is based on an analysis of the deviation of a stock's price from it's trend. Zones are the six areas under a normal bell-shaped curve defined by standard deviations. Zone 1 represents the area that is between two and three standard deviations below the mean. Zone 6 is at the other extreme. Zones 1 and 6 are the farthest points from a stock's mean, or where it has historically migrated during reversion to the mean. The mean is the vertical line bisecting the normal curve and it's called the trend.
Because it's future distribution we're concerned about, the implied volatility for the stock is used to estimate that standard deviation. Implied volatility is the annualized standard deviation that justifies the current options price. This is a particularly important statistic because it's the only market-derivable statistic that represents a forecast of future price movements.
We use two time frames for analysis, 10 days and 90 days. There's nothing magical about these two time frames, they were chosen because they fit the profile of a short-term trader and options hedger.
In the process of the evaluation, each Zone is expanded to a 33-point scale. A stock that is at the three standard deviation limit, or Zones 1 and 6, could then be said to be either 99% oversold (Zone 1) or 99% overbought (Zone 6).
The beauty of the Zone system is that it's easy to use. By simply identifying which Zone a stock's in, you can formulate a strategy. Next week we'll describe a tool we've named the Options Strategy Spectrum. The similarity between the Options Strategy Spectrum and the normal distribution curve is no coincidence. They're the same, but we've broken down the bell curve into Zones that delineate which stock-and-options strategy is appropriate at the time. Zones 1, 2 and 3 are below the mean (or oversold), while Zones 4,5 and 6 are above the mean (or overbought).
The Zone system is simply another way of looking at the market, but from a risk perspective. One advantage of the system is that it allows direct comparison of the overall market, market sectors and individual stocks at the same time. Every market index, sector index and individual issue will visit each Zone over the course of time. When issues move to the extreme Zones, the probability is high that the next move will be back toward the mean, assuming the volatility estimate delivered by the market proves reliable.
The Zone system can be compared to a map. While a map may be of significant benefit in determining where you are headed, it's most important contribution is detailing where you are right now. If you don't know your current location, it's nearly impossible to locate the path to your desired destination.
Upset Stomach
The market is acting like it ate some bad sushi over the weekend. Things are jouncing up and down inside, when usually it's a smooth ride. You can pour some Pepto on the problem, but eventually it's going to have to be processed on out. You know how that goes. But then the market will feel all better, and we'll be rallying in the fourth quarter.
First we gotta get rid of this bug. We don't think it will end until the bond ETFs and the yield indexes move to extreme extremes, like Zone 8. Reason: The vehicles we use to follow these moves carry low trading volume, so their implied volatilities (IVs) are underestimated. Right now, bond ETFs -- which carry the more reliable IVs -- are less than one standard deviation above their 90-day means. Plenty of room to rise, which is bad news for the stock market.
"Rumors have been floating that many Wall Street firms have forged agreements not to mark down the value of securities on their balance sheets in order to cease further disruption and help smooth out their future earnings. Such action may give firms more time to work out bad debt or rejigger their portfolios, but only time will tell if that serves to solve the broader credit woes or will only result in magnifying the problem." -- Mark DeCambre, TheStreet.com
Interestingly, this was the last paragraph in the article. Yet it's the most important item. How could it possibly help? The problem is not going away. People will lose their homes, the banks will have to take them back. But even before all that happens, these bonds will be worthless. Remember, this is going to end with one of the biggest blowouts -- percentage wise -- of all times. Buy the stock market here at your own risk.
First we gotta get rid of this bug. We don't think it will end until the bond ETFs and the yield indexes move to extreme extremes, like Zone 8. Reason: The vehicles we use to follow these moves carry low trading volume, so their implied volatilities (IVs) are underestimated. Right now, bond ETFs -- which carry the more reliable IVs -- are less than one standard deviation above their 90-day means. Plenty of room to rise, which is bad news for the stock market.
"Rumors have been floating that many Wall Street firms have forged agreements not to mark down the value of securities on their balance sheets in order to cease further disruption and help smooth out their future earnings. Such action may give firms more time to work out bad debt or rejigger their portfolios, but only time will tell if that serves to solve the broader credit woes or will only result in magnifying the problem." -- Mark DeCambre, TheStreet.com
Interestingly, this was the last paragraph in the article. Yet it's the most important item. How could it possibly help? The problem is not going away. People will lose their homes, the banks will have to take them back. But even before all that happens, these bonds will be worthless. Remember, this is going to end with one of the biggest blowouts -- percentage wise -- of all times. Buy the stock market here at your own risk.
Tuesday, August 7, 2007
Options Tuesday -- The BuyWrite Is Back
One of the consequences of a market pullback is higher option implied volatility. The CBOE's measure, VIX, climbs dramatically during pullbacks. But the key is whether the increase in option implied volatility (IV) sticks when the market eases up a bit. This time, it has.
That makes the case for establishing buy/writes all the more compelling. We like to use the strategy on issues that have fallen into Zone 2 on a 90-day basis, and are near 100% oversold on a 10-day basis. We like to see the longer term Zone 2 reading -- more than one standard deviation below the mean -- because of the stock, and we like to see the shorter term, extremely oversold reading for the option we're selling. A washed out stock has a greater chance of reverting to the mean over time, and it's risk of falling is lower than a stock that has risen significantly over time. And when we see a washed out stock that gets that final, volatile push down to 100% oversold over the short term, we know that the IV we'll be selling (in the form of option premium) is the highest we're going to get for that particular issue.
For example, the 52-week range on the VIX is 9 to 26. Today the VIX traded between 24 and 21. The low for the range, 9.39 to be exact, came when the market was at its peak. That's a nearly three-fold increase, from top to bottom. When the market rallies and IV reaches its peak, that's the best time to buy puts. But we'll leave that for another Options Tuesday.
We like buy/writes on fundamental favorites from oversold sectors, such as retail, internet commerce and broker/dealer. Look for 15% called profit on trades of three or four months.
That makes the case for establishing buy/writes all the more compelling. We like to use the strategy on issues that have fallen into Zone 2 on a 90-day basis, and are near 100% oversold on a 10-day basis. We like to see the longer term Zone 2 reading -- more than one standard deviation below the mean -- because of the stock, and we like to see the shorter term, extremely oversold reading for the option we're selling. A washed out stock has a greater chance of reverting to the mean over time, and it's risk of falling is lower than a stock that has risen significantly over time. And when we see a washed out stock that gets that final, volatile push down to 100% oversold over the short term, we know that the IV we'll be selling (in the form of option premium) is the highest we're going to get for that particular issue.
For example, the 52-week range on the VIX is 9 to 26. Today the VIX traded between 24 and 21. The low for the range, 9.39 to be exact, came when the market was at its peak. That's a nearly three-fold increase, from top to bottom. When the market rallies and IV reaches its peak, that's the best time to buy puts. But we'll leave that for another Options Tuesday.
We like buy/writes on fundamental favorites from oversold sectors, such as retail, internet commerce and broker/dealer. Look for 15% called profit on trades of three or four months.
Monday, August 6, 2007
Illiquidity -- Another Name for Sell on the Bid
The malaise that's infected the housing market has found a new host -- the credit market. They're calling it "a lack of liquidity," but it's really just people putting off as long as possible the inevitable -- selling to the bidders. In Florida over the past six months, you could have sold your home if you had been willing to hit the bid. No longer. Like the junk-bond market this week, the bids have been pulled.
Today's rally in the financials appears unsustainable. Hard to believe that UBS analyst would upgrade Merrill Lynch. There are too many unknowns still out on the table to make that call. Unlike the debt and housing markets, there is plenty of liquidity in the stock market. Probably because they're trading stocks with other people's money. But we still think there will be plenty of spillover from the complete shutdown in the housing industry.
Colleagues have told us that the levels of fraud committed during the housing bubble are unimaginable, and will dwarf the long-forgotten savings-and-loan scandal. Last year, one-third of US mortgages were interest-only or payment-option ARM. Four years ago, these choices barely existed. You can only imagine the lies that were told, on both sides, to get people who weren't qualified into homes they couldn't afford. And now, with lending and credit standards being tightened, there is no one to sell these homes to except the bank.
We think there's more downside to come this month. Hold onto your puts.
Today's rally in the financials appears unsustainable. Hard to believe that UBS analyst would upgrade Merrill Lynch. There are too many unknowns still out on the table to make that call. Unlike the debt and housing markets, there is plenty of liquidity in the stock market. Probably because they're trading stocks with other people's money. But we still think there will be plenty of spillover from the complete shutdown in the housing industry.
Colleagues have told us that the levels of fraud committed during the housing bubble are unimaginable, and will dwarf the long-forgotten savings-and-loan scandal. Last year, one-third of US mortgages were interest-only or payment-option ARM. Four years ago, these choices barely existed. You can only imagine the lies that were told, on both sides, to get people who weren't qualified into homes they couldn't afford. And now, with lending and credit standards being tightened, there is no one to sell these homes to except the bank.
We think there's more downside to come this month. Hold onto your puts.
2007 -- So Far, So Good
It's been a good trading year for us so far. We caught the market peak in January and got out, then we jumped back in again after March. We got good and scared again heading into July, and now we're waiting for the perfect opportunity to get back in. We could buy now and profit this year, but we think the true Blue Light Specials haven't shown up just yet.
Overall this year, we've been buying the oils and selling the homebuilders. Our broker/dealer indicator has provided us with a couple of nice trading opportunities, and our bond indicators have kept us ahead of any major swings in the credit markets. You can't have a good opinion about where the market is headed next unless you have a good bond indicator, and ours is one of the best. We've also profited from trading the golds, one of the most volatile sectors around. Now we're looking at the biggest opportunity of the year, and we didn't have to suffer any losses on the way to the experience.
More specifically: We sold the broker/dealers in late Jan, then bought them back in mid-March for an 8% gain. We also went long at that point -- "Zone 1 for XBD" was the headline -- and carried our position until early June, we we said "We'd get out now." We took in 14% on that long trade. Turning short at the same time, we're up about 20% now. Soon we'll look to turn around again and go long the brokers. So far this year, we've made accumulated gains of about 42% on our broker/dealer recommendations.
Along with the broker/dealers. we look to the bond market to tell us where the stock market is headed. It's pretty simple: Yield indexes are liable to peak about the same time as the broker/dealers. The broker/dealer stocks just don't like strong bonds. Once the bonds peak again, the broker/dealers (and the yield indexes) will be free to rise again. That will start the rally that should take us through the end of the year.
Yields peaked in late January, then they bottomed in mid-March. Yields peaked again in late May, and here we are now. The market likes strong yields, but yields are still falling. When they turn, so will the market.
Economically, we're long the oils and short the homebuilders right now. That means we'll buy the oil when they get weak, but we won't short them when they get strong. And we'll short the homebuilders when they get strong, but we won't go long the builders when they're weak. (Although we might take one more stab at going long the builders soon, then get out earlier than usual.)
The long oil position has proved extremely profitable. The oil service stocks gained about 50% during their run from late January to late May. The big oils gained nearly 30% over that span. We got out after the market as a whole had turned down, but the oils were still going strong. Now we're looking at another wonderful opportunity, and we're just waiting to make the call.
We've done pretty well shorting the homebuilders, too. We made around 10% from January to April. But our current trade, which we're looking to close out soon, has the homebuilders down by 25% this time. Might be time to take our profits and run. Might even go long the homebuilders because the market is so wiped out, those guys will probably have a nice relief rally.
Finally, we'd had nice success trading the golds. We made five buy recommendations, and only one sell. All five buys were in the same range, and we were never down by any significant amount. Gold stocks are terribly range bound, but there is so much interest in them that the range is gigantic. We can make profitable trades by buying anytime the stocks hit the bottom range and selling anytime the stocks hit the top range. So we'll keep adding to our positions each time the bottom is made, then sell them all out when we get that significant top
The significant top came on July 23, when we said that the gold stocks -- which had rallied -- were liable to pull back with the rest of the market. Gone are the days when gold stocks moved as a counterpoint to the rest of the market. Nowadays, gold stocks trade with the market more than they trade against it.
Overall this year, we've been buying the oils and selling the homebuilders. Our broker/dealer indicator has provided us with a couple of nice trading opportunities, and our bond indicators have kept us ahead of any major swings in the credit markets. You can't have a good opinion about where the market is headed next unless you have a good bond indicator, and ours is one of the best. We've also profited from trading the golds, one of the most volatile sectors around. Now we're looking at the biggest opportunity of the year, and we didn't have to suffer any losses on the way to the experience.
More specifically: We sold the broker/dealers in late Jan, then bought them back in mid-March for an 8% gain. We also went long at that point -- "Zone 1 for XBD" was the headline -- and carried our position until early June, we we said "We'd get out now." We took in 14% on that long trade. Turning short at the same time, we're up about 20% now. Soon we'll look to turn around again and go long the brokers. So far this year, we've made accumulated gains of about 42% on our broker/dealer recommendations.
Along with the broker/dealers. we look to the bond market to tell us where the stock market is headed. It's pretty simple: Yield indexes are liable to peak about the same time as the broker/dealers. The broker/dealer stocks just don't like strong bonds. Once the bonds peak again, the broker/dealers (and the yield indexes) will be free to rise again. That will start the rally that should take us through the end of the year.
Yields peaked in late January, then they bottomed in mid-March. Yields peaked again in late May, and here we are now. The market likes strong yields, but yields are still falling. When they turn, so will the market.
Economically, we're long the oils and short the homebuilders right now. That means we'll buy the oil when they get weak, but we won't short them when they get strong. And we'll short the homebuilders when they get strong, but we won't go long the builders when they're weak. (Although we might take one more stab at going long the builders soon, then get out earlier than usual.)
The long oil position has proved extremely profitable. The oil service stocks gained about 50% during their run from late January to late May. The big oils gained nearly 30% over that span. We got out after the market as a whole had turned down, but the oils were still going strong. Now we're looking at another wonderful opportunity, and we're just waiting to make the call.
We've done pretty well shorting the homebuilders, too. We made around 10% from January to April. But our current trade, which we're looking to close out soon, has the homebuilders down by 25% this time. Might be time to take our profits and run. Might even go long the homebuilders because the market is so wiped out, those guys will probably have a nice relief rally.
Finally, we'd had nice success trading the golds. We made five buy recommendations, and only one sell. All five buys were in the same range, and we were never down by any significant amount. Gold stocks are terribly range bound, but there is so much interest in them that the range is gigantic. We can make profitable trades by buying anytime the stocks hit the bottom range and selling anytime the stocks hit the top range. So we'll keep adding to our positions each time the bottom is made, then sell them all out when we get that significant top
The significant top came on July 23, when we said that the gold stocks -- which had rallied -- were liable to pull back with the rest of the market. Gone are the days when gold stocks moved as a counterpoint to the rest of the market. Nowadays, gold stocks trade with the market more than they trade against it.
Saturday, August 4, 2007
Broker/Dealers '07
We consider Broker/Dealer (XBD) our main market indicator. Wherever the market is heading, XBD moves there first. If XBD doesn't support a move by the rest of the market, something is wrong with the move.
Prior to this year, there were very few significant pullbacks by the XBD this century. Now that interest rates are back to normal, we're getting some significant rotation from the brokers.
In late January, XBD surged to new highs. There has been no value to shorting XBD when it moves to two standard deviations above its mean. Still, we noted the event by writing "Bonds continued to fall last week, with rates rising. Broker/Dealer (XBD) generally rallies along with rates, or opposite bonds. XBD fell just short of Zone 6 this time -- when was the last time that happened? The market is due for a correction, including a Zone 1 reading, and the first quarter of the year is a good time for it." At the time, Broker/Dealer (XBD) was trading at 254.
By March 12, XBD had dropped to more than two standard deviations below its mean. That prompted us to devote our front page to the index, with the headline "Zone 1 for XBD." The index experienced a turnaround during the week before the XBD issue. In that issue, we wrote "...the index bottomed out at 69% oversold on a 90-day basis, and 143% oversold on a 10-day basis." The index had rallied at bit by the time we wrote that weekend, but on March 12 Broker/Dealer (XBD) was at 234.
Nearly three months later, it was time to get out. On June 4, we said "The DYR Phase Chart has resumed its march upward, and now stands at -53 in Zone 6. The yield indexes are in Zone 6 over both 10 and 90 days. Broker/Dealer (XBD) is one of the strongest sectors again. All is well with the market. We'd get out now. Sell in May and go away sounds about right." At the time, Broker/Dealer (XBD) was trading at 267.
Since XBD wasn't leading any rallies this year, we were worried. On July 16, we said "We're just waiting for Broker/Dealer (XBD) to start leading the market south. Notice that XBD -- Zone 4 over both 10 and 90 days -- has chosen not to participate in this most recent rally...One thing that could send XBD reeling is a rally in bonds. The financials usually do well when yields are rising, and it looks like the peak in yields has been reached for the short term. Keep a close eye." At the time, Broker/Dealer (XBD) was at 262.
A week later, we got the sign we were looking for. We titled our July 23 issue "Time For Puts." We said "Broker/Dealer (XBD) has broken down. As bond indexes have rallied back to 90-day neutral, the brokers have retreated down into Zone 3. Now XBD stands as one of the weakest sector indexes, over both 90 days and 10 days. We think the market follows the brokers. That means it's time to buy puts on the market and certain sectors." At the time, Broker/Dealer (XBD) was at 249.
We don't think XBD has bottomed yet. Should be soon. Right now, Broker/Dealer (XBD) is at 214. That's down 20% since we said to sell in May and go away.
Send us an email and we send you a report containing all our comments about Broker/Dealer (XBD) so far this year.
Prior to this year, there were very few significant pullbacks by the XBD this century. Now that interest rates are back to normal, we're getting some significant rotation from the brokers.
In late January, XBD surged to new highs. There has been no value to shorting XBD when it moves to two standard deviations above its mean. Still, we noted the event by writing "Bonds continued to fall last week, with rates rising. Broker/Dealer (XBD) generally rallies along with rates, or opposite bonds. XBD fell just short of Zone 6 this time -- when was the last time that happened? The market is due for a correction, including a Zone 1 reading, and the first quarter of the year is a good time for it." At the time, Broker/Dealer (XBD) was trading at 254.
By March 12, XBD had dropped to more than two standard deviations below its mean. That prompted us to devote our front page to the index, with the headline "Zone 1 for XBD." The index experienced a turnaround during the week before the XBD issue. In that issue, we wrote "...the index bottomed out at 69% oversold on a 90-day basis, and 143% oversold on a 10-day basis." The index had rallied at bit by the time we wrote that weekend, but on March 12 Broker/Dealer (XBD) was at 234.
Nearly three months later, it was time to get out. On June 4, we said "The DYR Phase Chart has resumed its march upward, and now stands at -53 in Zone 6. The yield indexes are in Zone 6 over both 10 and 90 days. Broker/Dealer (XBD) is one of the strongest sectors again. All is well with the market. We'd get out now. Sell in May and go away sounds about right." At the time, Broker/Dealer (XBD) was trading at 267.
Since XBD wasn't leading any rallies this year, we were worried. On July 16, we said "We're just waiting for Broker/Dealer (XBD) to start leading the market south. Notice that XBD -- Zone 4 over both 10 and 90 days -- has chosen not to participate in this most recent rally...One thing that could send XBD reeling is a rally in bonds. The financials usually do well when yields are rising, and it looks like the peak in yields has been reached for the short term. Keep a close eye." At the time, Broker/Dealer (XBD) was at 262.
A week later, we got the sign we were looking for. We titled our July 23 issue "Time For Puts." We said "Broker/Dealer (XBD) has broken down. As bond indexes have rallied back to 90-day neutral, the brokers have retreated down into Zone 3. Now XBD stands as one of the weakest sector indexes, over both 90 days and 10 days. We think the market follows the brokers. That means it's time to buy puts on the market and certain sectors." At the time, Broker/Dealer (XBD) was at 249.
We don't think XBD has bottomed yet. Should be soon. Right now, Broker/Dealer (XBD) is at 214. That's down 20% since we said to sell in May and go away.
Send us an email and we send you a report containing all our comments about Broker/Dealer (XBD) so far this year.
Bonds '07
We watch for bond ETFs and yield indexes to reach opposite extremes around the same time. Yield indexes tend to max out further from their respective means than do bond ETFs. When bond-and-yield extremes are reached, the market is about to change direction.
This year, we've had two full reversals from the bonds and yields. On January 29 we noted that bond ETFs were more than two standard deviations below their respective means, while yield indexes were more than three standard deviations above their respective means. We said "So it appears the bonds are reaching extremes. Further moves into the extreme Zones by yields and bonds could translate into serious losses for the market this week." At the time, the 30-Year Bond (TLT) ETF was at 86.91, while the 10-Year Interest Rate (TNX) index was at 48.79.
The turnaround happened quickly, so that reversion to the mean was already under way by weekend comment time. But the DYR Report on March 12 clearly detailed a serious reversal in the bond ETFs (now heading down again) and yield indexes (now heading up again) that happened during trading the previous Friday. At the time, 30-Year Bond (TLT) was at 89.4, while the 10-Year Interest Rate (TNX) was at 45.89.
The first move sent TLT (bonds) up 3%, while TNX (yields) dropped by 5%. Those are big moves for the bond-and-yield issues. Hard to trade, but they move markets.
The second reversal triggered the current market downdraft. On May 29, we said "The interest-rate indexes may have peaked last week too. All three durations are near 100% overbought over both 10 and 90 days. We've seen them higher before, but not with this much unity. Time to sell." At the time, 30-Year Bond (TLT) was at 86.43 while 10-Year Interest Rate(TNX) was at 48.61.
Extremes -- at the bottom for yield indexes and at the top for bond ETFs -- have not been reached yet for this cycle. This week, 30-Year Bond (TLT) is at 87.25, while 10-Year Interest Rate (TNX) is at 47.
This year, we've had two full reversals from the bonds and yields. On January 29 we noted that bond ETFs were more than two standard deviations below their respective means, while yield indexes were more than three standard deviations above their respective means. We said "So it appears the bonds are reaching extremes. Further moves into the extreme Zones by yields and bonds could translate into serious losses for the market this week." At the time, the 30-Year Bond (TLT) ETF was at 86.91, while the 10-Year Interest Rate (TNX) index was at 48.79.
The turnaround happened quickly, so that reversion to the mean was already under way by weekend comment time. But the DYR Report on March 12 clearly detailed a serious reversal in the bond ETFs (now heading down again) and yield indexes (now heading up again) that happened during trading the previous Friday. At the time, 30-Year Bond (TLT) was at 89.4, while the 10-Year Interest Rate (TNX) was at 45.89.
The first move sent TLT (bonds) up 3%, while TNX (yields) dropped by 5%. Those are big moves for the bond-and-yield issues. Hard to trade, but they move markets.
The second reversal triggered the current market downdraft. On May 29, we said "The interest-rate indexes may have peaked last week too. All three durations are near 100% overbought over both 10 and 90 days. We've seen them higher before, but not with this much unity. Time to sell." At the time, 30-Year Bond (TLT) was at 86.43 while 10-Year Interest Rate(TNX) was at 48.61.
Extremes -- at the bottom for yield indexes and at the top for bond ETFs -- have not been reached yet for this cycle. This week, 30-Year Bond (TLT) is at 87.25, while 10-Year Interest Rate (TNX) is at 47.
Housing '07
We're prepared to sell the Housing (HGX) index when it rallies to an extreme. We don't care to own it during rallies, because we think the trend is down.
This year we've recommended shorting housing twice. The first time we recommended shorting the index twice in three weeks, first on January 22 -- "Housing (HGX) is up near Zone 6, where it's a sell now" -- around 239, and two week later on February 5 -- "Housing (HGX) has hit Zone 6 over both 10 and 90 days" -- at 255. The buy-back recommendation for those two shorts came on April 9 -- "Housing (HCX) remains in Zone 1" -- with HGX at 218, which represented declines of 9% and 14%.
The second time we sold HGX was on June 21, when the headline of the DYR Report was "Start Buying Puts." We said "...we'd short Housing (HGX) again while it's around 90-day neutral. When we do make it back to Zone 1 this year, we think the housing stocks will be the downside leader." At the time, HGX was trading at 232.
The buy-back recommendation hasn't been made yet. On July 23 we said "The real-estate indexes, Dow Jones REIT (DJR) and Housing (HGX), are about halfway through Zone 2 and on their way to Zone 1." At the time, HGX was trading at 208, down about 10% since the short.
Going into this week, HGX stands at 175. That's down about 25% since the short.
Send us an email and we'll email you our special report containing all the quotes this year in the DYR Report that pertain to housing.
This year we've recommended shorting housing twice. The first time we recommended shorting the index twice in three weeks, first on January 22 -- "Housing (HGX) is up near Zone 6, where it's a sell now" -- around 239, and two week later on February 5 -- "Housing (HGX) has hit Zone 6 over both 10 and 90 days" -- at 255. The buy-back recommendation for those two shorts came on April 9 -- "Housing (HCX) remains in Zone 1" -- with HGX at 218, which represented declines of 9% and 14%.
The second time we sold HGX was on June 21, when the headline of the DYR Report was "Start Buying Puts." We said "...we'd short Housing (HGX) again while it's around 90-day neutral. When we do make it back to Zone 1 this year, we think the housing stocks will be the downside leader." At the time, HGX was trading at 232.
The buy-back recommendation hasn't been made yet. On July 23 we said "The real-estate indexes, Dow Jones REIT (DJR) and Housing (HGX), are about halfway through Zone 2 and on their way to Zone 1." At the time, HGX was trading at 208, down about 10% since the short.
Going into this week, HGX stands at 175. That's down about 25% since the short.
Send us an email and we'll email you our special report containing all the quotes this year in the DYR Report that pertain to housing.
Golds '07
We want to buy gold stocls when they're more than two standard devaitions below thier respective 90-day means, and sell them when they're two standard deviations above their respective means. We like gold, so we might even buy at one standard deviation below the mean.
We talked about buying the Gold/Silver (XAU) index around 135 a number of times this year. When we said it was time to take profits, the index was around 158. That's 15% to 20% profit, on each purchase we made.
Here are the five long XAU recommendations we've made so far this year:
-- On January 8, we said "..if you didn't get long when Gold/Silver (XAU) slid through 90-day neutral last week, now's a good time." At the time, XAU was at 133.
-- On March 19, we said "Is this the time to buy gold stocks again? We say yes." At the time, XAU was at 133.
-- On May 7, we said "The golds are the weakest group overall -- that's where we'd look for bargains now." At the time, XAU was at 142.
-- On May 14, we said "Gold/Silver (XAU) looks like a good buy here." At the time, XAU was at 140.
-- On May 29, we said "...it's time to take another stab at the gold indexes. The market is turning and Gold/Silver (XAU) has hit Zone 2. Time to buy." At the time, XAU was at 136.
Here's our only sell recommendation this year:
-- On July 23, we said "...it's time to take profits on Gold/Silver (XAU). The index is in Zone 6, just barely, over both 90-days and 10-days. It's hard to see the dollar falling lower. If the market tanks, golds will fall too." At the time, XAU was at 158.
Send us an email and we'll send you a report that includes all the comments we've made about the golds this year.
We talked about buying the Gold/Silver (XAU) index around 135 a number of times this year. When we said it was time to take profits, the index was around 158. That's 15% to 20% profit, on each purchase we made.
Here are the five long XAU recommendations we've made so far this year:
-- On January 8, we said "..if you didn't get long when Gold/Silver (XAU) slid through 90-day neutral last week, now's a good time." At the time, XAU was at 133.
-- On March 19, we said "Is this the time to buy gold stocks again? We say yes." At the time, XAU was at 133.
-- On May 7, we said "The golds are the weakest group overall -- that's where we'd look for bargains now." At the time, XAU was at 142.
-- On May 14, we said "Gold/Silver (XAU) looks like a good buy here." At the time, XAU was at 140.
-- On May 29, we said "...it's time to take another stab at the gold indexes. The market is turning and Gold/Silver (XAU) has hit Zone 2. Time to buy." At the time, XAU was at 136.
Here's our only sell recommendation this year:
-- On July 23, we said "...it's time to take profits on Gold/Silver (XAU). The index is in Zone 6, just barely, over both 90-days and 10-days. It's hard to see the dollar falling lower. If the market tanks, golds will fall too." At the time, XAU was at 158.
Send us an email and we'll send you a report that includes all the comments we've made about the golds this year.
Oils '07
We like the oils when they move one standard deviation below their respective 90-day means. We don't want to wait until they move two standard deviations below their respective means -- if they do, we'll buy more. We'll sell only once these issues move significantly beyond two standard deviations above their mean prices.
If you bought the oils when we said to in January, you would have made 50% on oil service and 27% on large oils by the time we said to get out in late June.
We saw a great opportunity to get into the oil issues back on January 16. In fact, that week's issue of the DYR Report was titled "Oil Opportunity." We said: "The rotation out of oils and into techs has been almost too perfect. Nasdaq 100 (NDX) has rallied back into Zone 5 as the oil service indexes have slipped into Zone 2. Both groups are due for a little reversion to the mean. But we'd buy the oils before we'd sell the techs." More: "Three months ago, the DYR Oil Sectors also made Zone 2. Two months later, those DYR Sectors were solidly in Zone 6." At the time, the Oil (XOI) index was at 1,11o and the Oil Service (OSX) index was at 185.
We noted the strength in the oils as the year progressed, but we didn't really issue a sell signal until the entire stock market turned down in June. On June 25, we wrote: "All of the broad-based indexes have pulled back into Zone 4. The oil indexes remain in Zone 6. Gas prices have declined recently. If the oils pull back too, we'd buy them again at 90-day neutral. There's still a war in Iraq. But the market has rallied right along with the oils, so we'd expect it to pull back with them as well." At the time, Oil (XOI) was at 1,412 and Oil Service (OSX) was at 278.
The gain in XOI was 27% and the gain in OSX was 50%. Send us an email and we'll send you a report that contains all of our comments about the oils so far this year.
If you bought the oils when we said to in January, you would have made 50% on oil service and 27% on large oils by the time we said to get out in late June.
We saw a great opportunity to get into the oil issues back on January 16. In fact, that week's issue of the DYR Report was titled "Oil Opportunity." We said: "The rotation out of oils and into techs has been almost too perfect. Nasdaq 100 (NDX) has rallied back into Zone 5 as the oil service indexes have slipped into Zone 2. Both groups are due for a little reversion to the mean. But we'd buy the oils before we'd sell the techs." More: "Three months ago, the DYR Oil Sectors also made Zone 2. Two months later, those DYR Sectors were solidly in Zone 6." At the time, the Oil (XOI) index was at 1,11o and the Oil Service (OSX) index was at 185.
We noted the strength in the oils as the year progressed, but we didn't really issue a sell signal until the entire stock market turned down in June. On June 25, we wrote: "All of the broad-based indexes have pulled back into Zone 4. The oil indexes remain in Zone 6. Gas prices have declined recently. If the oils pull back too, we'd buy them again at 90-day neutral. There's still a war in Iraq. But the market has rallied right along with the oils, so we'd expect it to pull back with them as well." At the time, Oil (XOI) was at 1,412 and Oil Service (OSX) was at 278.
The gain in XOI was 27% and the gain in OSX was 50%. Send us an email and we'll send you a report that contains all of our comments about the oils so far this year.
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