How NOT to Lose -97.5% in Semiconductors (Part II)

In Part 1, I highlighted the fact that semiconductor stocks (using ticker FSELX as a proxy) have displayed three distinct periods within each month that have significantly underperformed all other days by, ahem, a “significant” margin (in this instance, “significant” is defined as -83.5% for the “Bad Days” versus +17,805% for the “Good Days’).

I also dropped the slightly depressing news that you can’t actually use this strategy with ticker FSELX due to Fidelity’s switching restrictions.  There are two primary alternatives – the ETF ticker SMH or Profunds ticker SMPIX.  For our purposes we will use SMPIX for several reasons:

*A slightly higher correlation to FSELX

*No commissions or slippage

*The ability to invest a specific dollar amount (rather than having to buy a specific number of shares).

*SMPIX uses leverage of 1.5-to-1 so offers more “bang for the buck” (albeit with a commensurately higher degree of risk)

Trading with SMPIX

SMPIX started trading on April 30th, 2001. So let’s run the same test using SMPIX that we did in the last article with FSELX.  Specifically:

*During TDMs 5, 6, 7, 13, 14, -7, -6 and -5 our system will be in cash.

*During all other day the system will hold SMPIX

The results appear in Figure 1.

1

Figure 1 – Growth of $1,000 in SMPIX: TDM 5, 6, 7, 13, 14, -7, -6 and -5 (top clip) versus all other days (bottom clip); 5/1/2001-8/26/15

*$1,000 invested only on TDM 5, 6, 7, 13, 14, -7, -6 and -5 declined to $25 (-97.5%)

*$1,000 invested during all other days grew to $16,812 (+1,581%)

Now the Caveats

There are certainly a few caveats to ponder in all of this:

*These results certainly appear to fall into the “too good to be true” category (but they are mathematically correct)

*The real question is “what is the likelihood that future results will resemble past performance?”  Unfortunately, there simply is no way to predict this.  So a large “leap of faith” is required.

*Trading three times every single month can be a little “grinding” for those who are not used to shorter-term trading, especially since…..

*….There can be no second-guessing (“Hmmm, things look pretty good, maybe I won’t bother selling this time around”)

*Also, while this “system” has sidestepped a lot of pain, no one should assume that the “Good Days” are guaranteed to be a blissfully painless way to generate profits beyond the Dreams of Avarice.

To illustrate this last caveat take a close look at Figure 2.  This is the same chart that appeared in the bottom clip in Figure 1, only with a few not inconsequential drawdowns highlighted.2Figure 2 – “Good Days” aren’t always so good

As you can see, even the “Good Days” took some huge hits along the way.

Summary

So is trading in and out of SMPIX three times a month a viable strategy?  For the record, I am not recommending this as a strategy; I am simply reporting the results I’ve found.  I leave you to decide for yourself what – if anything – to do with it.

Remember that the title was not “How to Make Easy Money with No Risk in Semiconductors”, but “How NOT to lose 97.5% in Semiconductors.”

As it turns out, there is a difference.

Jay Kaeppel

 

How NOT to Lose -97.5% in Semiconductors

Alright, I will admit that this one is a little “out there”, even by my highly flexible standards.  As you may know I follow a lot of seasonal patterns and trends among various financial markets, indexes, commodities and even some individual stocks.

(See also Life Beyond Buy and Hold)

The good news regarding seasonal trends is that some of them have shown to be surprisingly (and amazingly) consistent.  The bad news regarding seasonal trends is twofold:

1) There is never any guarantee that a given trend will work “this time around” (or even “ever again” for that matter).

2) Hence, a certain “leap of faith” is required in order to put real money at risk based solely on the date on the calendar

Trading Days of the Month

The stock market as a whole has showed a propensity to be more bullish during the first/last few days of the month (and also roughly mid-month) than during other days of the month.  And although this idea was first popularized by Norman Fosback in his market classic “Market Logic” way back in 1975, this trend has persisted.

The same is true for many other stock market related securities.  The one caveat to considering trading days of the month (TDM) is that one should put more faith in “clumps” of days that tend to rise (or fall) consistently than in random individual days.  That being said, let’s turn our attention to semiconductor stocks. We will use Fidelity Select Electronics (FSELX) as our proxy for the sector and start our test on 10/3/1988.

For comparison sake, from 9/30/1988 through 8/24/15 $1,000 invested in FSELX grew to $29,518 (or +2,851.8%).

Trading Days 5, 6 and 7

The top clip in Figure 1 displays the growth of $1,000 invested in FSELX only during trading days #5, 6 and 7 every month since 1988.  The bottom clip shows the results from investing in FSELX during all other days.567Figure 1 – FSELX TDM 5, 6 and 7 (top clip) versus all other days (bottom clip); 10/3/88-8/24/15

*$1,000 invested only on TDM 5, 6 and 7 declined to $607 (-39.7%)

*$1,000 invested during all other days grew to $48,640 (+4,764)

Trading Days 13 and 14

The top clip in Figure 2 displays the growth of $1,000 invested in FSELX only during trading days #13 and 14 every month since 1988.  The bottom clip shows the results from investing in FSELX during all other days.1314Figure 2 – FSELX TDM 13 and 14 (top clip) versus all other days (bottom clip); 10/3/88-8/24/15

*$1,000 invested only on TDM 13 and 14 declined to $343 (-65.7%)

*$1,000 invested during all other days grew to $86,128 (+8,513)

Trading Days -7, -6 and -5

This requires a little explanation.  For this sequence we start counting on the last trading day of the month which is TDM -1.  So technically we are looking at the 6th, 5th and 4th from last trading day of the month.  Also note that there can be overlap between TDM 13 or 14 and TDM -7, -6 and -5.  But for now we are looking at each period separately.

765-Figure 3 – FSELX TDM -7, -6 and -5 (top clip) versus all other days (bottom clip); 10/3/88-8/24/15

*$1,000 invested only on TDM -7, -6 and -5 declined to $314 (-68.6%)

*$1,000 invested during all other days grew to $97,743 (+9,674.3%)

Putting It All Together

Now at this point many serious students of the markets will shout “Curve Fitting.”  And there is something to that.  As a proud graduate of “The School of Whatever Works” I personally am rarely distracting by those charges.  But I certainly respect each trader’s right to look skeptically at the results presented here.  Still, the numbers are what they are.  And just to make it interesting, let’s now put all three of the monthly periods together.

The following test assumes a lot of trading as follows:

*During TDMs 5, 6, 7, 13, 14, -7, -6 and -5 our system will be in cash.

*During all other day the system will hold FSELX

The results appear in Figure 4.

4Figure 4 – FSELX TDM 5, 6, 7, 13, 14, -7, -6 and -5 (top clop) versus all other days (bottom clip); 10/3/88-8/24/15

$1,000 invested only on TDM 5, 6, 7, 13, 14, -7, -6 and -5 declined to $165 (-83.5%)

$1,000 invested during all other days grew to $179,058 (+17,805.8)

Figure 5 displays the results of the “System” versus buying and holding ticker FSELX.

5Figure 5 – FSELX avoiding TDM 5, 6, 7, 13, 14, -7, -6, -5 (blue) versus buy-and-hold (red); 10/3/88-8/24/15

Summary

So is this just another crackpot curve-fit idea, or is there something to this?  I leave you to decide for yourself. One important thing to note for anyone who is intrigued – you cannot actually use this “system” with ticker FSELX.  If you were to try, after a very short time you would receive a very terse communication from the fine folks at Fidelity informing you, a) that they have very specific switching restrictions, b) that you are in violation of said restrictions and, c) that if you attempt to persist they may be required to send a few burly customer reps to your home and wrestle you to the ground before you can hit “Enter” to place your next trade.  Or something to that effect.

Also, what about that -97.5% figure in the title?

Check back for Part II.

Disclaimer: OK, I made up part c) above.  And I am a Fidelity investor.

Jay Kaeppel

 

Silver Resumes its “Wave” Goodbye

On occasions in the past I have mentioned the idea of using Daily and Weekly Elliott Wave counts that are in sync as a tool to identify trading opportunities.

(See also JayOnTheMarkets.com: Life Beyond Buy and Hold)

Most recently, silver (using the ETF ticker SLV) came up as a bearish candidate back in ??. Following a plunge and then a rally, SLV has resumed its downtrend, breaking down to  new lows in the process.

Figure 1 displays the daily and weekly Elliott Wave counts.  A trader paying attention to these two counts acting in concert might have considered using the recent rally in SLV as an opportunity to sell short or to establish a bearish options position using options on SLV.

1Figure 1 – Daily and Weekly Elliott Wave counts for SLV remain bearish (Courtesy: ProfitSource by HUBB)

Summary

The purpose of this article is not necessarily to trigger you to take some sort of action in SLV.  It may be getting a little late to start getting bearish on SLV (although a break to new lows is obviously not bullish).  The point of this is not to tell you what to do or not to do in silver.

The point is simply to highlight the potential usefulness of dueling bullish (or bearish) Elliott Wave counts in identifying trading opportunities.  As far as SLV is concerned, its “Mission Accomplished”.

Jay Kaeppel

 

Life Beyond Buy and Hold

In my last piece I mentioned the importance of (at least in my opinion) doing something more than just buying and holding stocks and/or mutual funds.  Nothing wrong with putting some money into the market and leaving it there, but if that’s all you ever do then, well, repeating now:

An investor who puts all of his or her money in the stock market and leaves it there is (in my opinion) like a ship at sea without a rudder.  When the winds are favorable things will go really well.  When a storm arises some very, very bad things can happen and you have absolutely no control (except to hold on tight and hope the storm passes while you are still afloat).

So for what it is worth, ponder the “approach” listed below:

*40% on a buy-and-hold basis in the stock and/or bond markets

*30% in objective trading and/or investment strategies that can outperform over time

*20% in short-term trading strategies (can go to cash and maybe go short, and may include options trading)

*10% in cash or hedging positions

You can include only 2 or 3 of the above and you can change up the percentages anyway you’d like.  The point is not that the categories and percentages that I mentioned above are “optimal.”  The point is that this approach of diversifying among different trading strategies affords you multiple opportunities to make money – possibly even while the stock and/or bond market is not performing well.

The Role of Objective Strategies

When I mention “30% in objective trading and/or investment strategies” I am talking about strategies with specific trading rules that can be back tested in order to give you some idea regarding potential returns.  While “future results are never guaranteed” at least you can have some idea of what to expect and probably even more importantly, there will be no emotional reactions to market events.  The trading rules trigger as designed and are followed rigorously.

Two strategies of note in this regard were developed by Alpha Investment Management, Inc. The company offers five managed account programs, each of which track a specific, objective trading strategy (including the Multi-Income Strategy for which I am the portfolio manager).

The two that I wish to highlight here are the Bonds Strategy and the Mid-Cap Power Index Strategy.  Both of these strategies have excellent long-term track records and notably, both managed to sidestep the stock market plunge last week.

The Alpha Mid-Cap Power Index Strategy has sported an average annual gain of +13.23% (after fees) for the 15.5 years ended June 30, 2015**.  As of June 30, 2015 the program was up +3.2% for the year and was (and still is) invested in an Intermediate Term Treasury Index fund.

** – Disclaimer: Past results are no guarantee of future results

Strategy Methodology: Each year, the Alpha Mid-Cap Power Index Managed Account holds an S&P Midcap 400 Index fund from late-October to the end of May and then invests in an Intermediate Treasury Index fund for the remaining months of the year. As a result, equity exposure is constrained to 60% of the available trading days each year.  During the fourth quarter of each year, the strategy raises the beta of the mid-cap index fund by 50% during three “power period” trades totaling 20 days. These three sub-periods are influenced by end-of-month and holiday seasonal forces which are particularly robust in small and mid-cap stocks.

The Alpha Bonds Strategy has sported an average annual gain of +8.4% (after fees) for the 15.5 years ended June 30, 2015**.  As of June 30, 2015 the program was up +0.3% for the year and was (and still is) invested 40% in intermediate corporate high grade bonds, 30% in intermediate term treasuries, and 30% in low duration securities (which reduces volatility due to interest rate changes).

** – Disclaimer: Past results are no guarantee of future results

Strategy Methodology: Each year, from January 1 until late-October, the Alpha Bonds Strategy holds a position of 70% intermediate-term bond funds / 30% short-term bond funds. Then in late-October, 40% of the portfolio remains in intermediate-term bond funds while 60% of the portfolio is devoted to three “power period” trades invested in a Russell 2000 Index fund leveraged by 50%. While not invested in the three fourth quarter trades, 60% of the funds are allocated to cash/money market fund.

For more information about these or any of the Alpha Strategies visit http://www.Alphaim.net.

Summary

The purpose of highlighting these two programs is simply to illustrate the fact that it is possible to make money in the stock and bond markets using objective trading strategies and that it is possible to do so while also avoiding some of the pain and suffering that can accompany traditional stock and bond market investing.

Diversifying the types of strategies that you use can not only enhance your long-term investment results, but can greatly reduce overall portfolio volatility.

Jay Kaeppel

 

The Importance of Respecting the Trend

The trend is your friend. OK, you’ve probably heard that before.  But there is a good reason that this phrase is heard so commonly among traders.

For those who were willing to hear what the market was saying, there was some advance warning that trouble was brewing.  A glance at Figure 1 shows us that the major market measures – the Dow, the S&P 500 Index, the Russell 2000 small-cap index and the Vanguard Total World Stock Index ETF – were all breaking down below their respective 200-day moving averages prior to “the Plunge”.

1Figure 1 – Stock Market Indexes signaling “trouble” prior to the “Plunge”

See also This is Why We Trade

OK, for the record I am not an “investment advisor”, on this blog I do not make “recommendations” and I never – OK, rarely – try to make “predictions” (because quite frankly, who needs the humiliation).

I do know something about following a trend, however, and for the record I did issue something of a warning (OK, more like a veiled threat) in this article on July 28th.

Also, on 8/11 the Dow Industrials experienced what is widely known as the “Death Cross” – which occurs when the 50-day moving average drops below the 200-day moving average.  Now I also (mostly) try to avoid casting stones at other financial writers (glass houses and what not).  So as a result, I did not write the article about how it concerned me a great deal that within 48 hours of the Dow “Death Cross” I came across roughly 352 articles telling me that the “Death Cross” doesn’t mean a thing because “sometimes it works and sometimes it doesn’t”.

Now here is the important point:

All roughly 352 authors were technically correct that sometimes the Death Cross “works” (i.e., prices head significantly lower) and sometimes it does not.  But the fact of the matter is – at least in my opinion – that the trend must be respected at all times.  No one likes to get whipsawed, and no you do not have to “sell everything”, every time a stock index drops below its 200-day moving average.  BUT, when lots of indexes start breaking down at the same time the one thing you cannot do is simply DISMISS IT!!

As I mentioned, a Death Cross or a drop below a particular moving average does not have to mean “sell everything.”  But it should mean “protect yourself just in case.”  That might mean raising some cash or hedging with options, etc.

What Should I Do Now?

That seems to be the question everyone asks after a market plunge.  That and “Where does the market go from here”.  Now as a “financial analyst type” I know that people or sort of trained to expect that the next thing I will do is discuss where I think the market is headed from here and what you should do now.  But, like I said, I don’t “do predictions”.  So for the moment I won’t bother telling you where I think the market is headed next.  But I think I can answer the “What Should I Do Now” question.

Jay’s Trading Maxim #29: If you had a trading plan that you were following yesterday, you should continue following it today.

Now I admit that may sound a bit snarky but it is not intended to. For if your approach to trading is to do one thing, and then when trouble arises you start to do something else, then – let’s face it – you don’t really have much of a plan.

For what it is worth, I will say that I am OK with “buy and hold” with a portion of a portfolio.  I have some mutual funds that I think I have held for what could be close to 30 years.  I’ll sell those when I need the money.  But not before.

But I am not a fan of “only buy-and-hold”.  An investor who puts all of his or her money in the stock market and leaves it there is (in my opinion) like a ship at sea without a rudder.  When the winds are favorable things will go really well.  When a storm arises some very, very bad things can happen and you have absolutely no control (except to hold on tight and hope the storm passes while you are still afloat).

So for what it is worth, ponder the “approach” listed below:

*40% in the stock and/or bond markets on a buy-and-hold basis

*30% in objective trading or investment strategies that can outperform over time (see some other articles on this site for some ideas. Another site to peruse for examples of objective strategies is wwwQuantocracy.com)

*20% in short-term trading strategies (can go cash and ply the short side, and may include options trading)

*10% in cash or hedging positions

Nothing magic about this formula.  But this type of diversified approach allows an investor to attack the financial markets from a variety of angles.

Which looks like a pretty good idea right about now.

Jay Kaeppel

 

This is Why We Trade

This is why we trade.

When the world goes to heck in a hand basket and seemingly cataclysmic events swirl around us completely out of our control, we remain the “captain of our own ship.”  The value of our house may decline. The business that supports our livelihood may suffer anywhere from minimal to major damage. Our 401K may start to look like a 201K. Politicians on all sides blather on attempting to assess blame as far away from them as possible. Talk of the next Great Depression may become more common. Yes, the perception may be that it is all imploding down around us.

This is why we trade.

Not because it’s cool or fun, or an interesting hobby. Not because we have all of these fast computer and lots of data and an endless array of tools and techniques to work with. Not because we enjoy exchanging ideas with other individuals regarding the latest and greatest methods and techniques. Not because we enjoy telling our friends about or latest conquest in the markets or draw comfort from commiserating with others regarding our most recent losing trade.

We trade because trading is the only business that allows us the opportunity to make money regardless of the events that go on around us. Granted we must be on the right side of those events – or at least not be on the wrong side for very long – in order to prosper. But that is a given. Unlike true gambling related endeavors, if we make a bad bet, we can with as much haste as possible, pull our bet off the table and wait for a better opportunity.

Many who consider themselves to be “red-blooded Americans” have an aversion to selling short. Too much risk, too much uncertainty, and doggone it we like it when things go up not down. And in a perfect world that would be great. If you dare take your hands from over your eyes and survey the current state of affairs the odds are good that you will conclude that this is presently not a perfect world.

But you see, this is why we trade.

When those things around us are good we can take a long position and

prosper. When those things around us head south we can sell short and do the same. Wait a minute. Doesn’t that make us “evil speculators?”  Not by any sane definition. By any sane definition we are simply people who prefer to shape our own destinies rather than rely on others to do it for us. We are simply people who when faced with adversity would prefer to take responsibility rather than sit around and whine and complain that no one is bailing us out. People who trade are the true capitalists. And while some seem to be taking great glee in disparaging capitalism these days, the fact is that those people are fools.

Freedom – not only freedom to live as you choose but to make your own way in the world – is the single greatest “entitlement.” Slowly but surely this right seems to be slipping from our grasp. More and more the “powers that be” attempt to assert greater control over the everyday lives of others.  And I am talking about politicians from both sides of the political spectrum.  This more than anything explains the great unraveling that we are witnessing today. And we also must recognize our own culpability in all of this. Perhaps if we had looked up more often from our big screen TV’s and laptops and iPhones, we would not be where we are.  But we are.

Which of course, is just one more reason why we trade.

Somewhere in the past two decades too many people came to the conclusion that because we now have high technology that we are somehow impervious to the economic cycle. So let me be the first to say, “Welcome back to reality.”

Still, this is why we trade.

Unless and until they close down the exchanges and simply have government set the price for everything, we have the opportunity to continue to live a decent lifestyle. Until the income tax approaches 100% (somewhere, some politician just read this and thought, “Why didn’t I think of that?”), we can take steps to continue to make money as other avenues dwindle. No politician is going to solve the current state of affairs. Only “the people” can do that. And this week some of those people actually stirred from their slumber.

The “Current Crisis” versus “Past Crises”

How this current market decline will work out in the end is a subject of great debate.  I will spare you my “prediction”.  I do so simply because if I lined up all of the predictions I have made over the years as well as all of the predictions that I have heard others make over the years it would start to look a lot like those endless miles of government red ink.

And this too, is why we trade.

By not being fully locked into the “buy and hold” mentality we retain the flexibility to take advantage of new opportunities as they arrive and to cut our risk significantly when things get too volatile and unstable.  And if we trade with an eye towards minimizing risk, we find ourselves losing only a small amount even when we are spectacularly wrong in our market opinions.

Which – oddly, is a good thing.

Which is just one more reason why we trade.

Summary

Contrary to what you might expect me to say at this point, I believe that there is absolutely nothing wrong with investing a portion of your money using a long-term buy and hold approach.  If for example, you want to put a portion of your income into a mutual fund or ETF and let it ride for the long-term, by all means go ahead.  But also remember that if you do so with all of your money then your portfolio is essentially like a ship at sea without a rudder.  As long as the wind and tides move in a favorable direction you may eventually reach your destination.  But the fact remains that you are trusting outside forces to control your own destiny.

By taking the time to develop and/or learn a small handful of trading techniques, entry and exit techniques, position sizing, money management and risk control, you afford yourself the potential to stand at the wheel as the captain of your own ship charting your own course in even the most turbulent waters.

As I said, this is why we trade.

Jay Kaeppel

The Pound in the Balance

OK, I know that the British Pound is not a market that most people follow.  Still, at times it pays to remember:

Jay’s Trading Maxim #312: Opportunity is where you find it, not necessarily where you want it to be.

(Hey, that one’s pretty good….I must have stolen it from someone.  Anyway…)

See also JayOnTheMarkets.com: Jay Kaeppel Named Portfolio Manager for New Investment Program

I wrote about this awhile back and since that time the Pound (I am using ETF ticker FXB here instead of British Pound futures simply based on the guess that 99% of the people who read this have never and will never trade British Pound futures) has mostly traded sideways.  In the last several sessions the Pound has tried to breakout to the upside but has been unable to.

(Also the Sep 153 put that I highlighted at $1.80 is presently trading at $1.05 – illustrating the negative effects of time decay.  Still, that trade can make money quickly if FXB sells off prior to September expiration)

1Figure 1 – FXB at a critical juncture (Courtesy: ProfitSource by HUBB)

The Elliott Wave count as shown in Figure 2 is still pointing to the possibility of a meaningful price decline.  So for those who are willing to accept the “mental risk” (meaning that there is a good chance you might end up kicking yourself and saying “why did I do something so stupid and impulsive?”) a short-term bearish trade with a stop above recent highs could offer a very high profit-to-risk ratio (again with the caveat that the probability of profit may be low since a tight stop will be used).

2Figure 2 – Bearish Elliott Wave projections for Daily (top) and Weekly (bottom) FXB charts (Courtesy: ProfitSource by HUBB)

Playing with Options

What follows is not a recommendation but rather an example of a simple “way to play.”  IMPORTANT NOTE: The option used in the following example has an Open Interest of exactly 0. It also has a wide bid/ask spread so anyone tempted to “take the plunge” should make note slippage is inevitable if a quick exit is called for.  Also, nothing less than a meaningful decline in FXB will allow this option to generate a profit.  That being said:

This trade involves buying the at-the-money December 154 put.  The bid is $3.00 and the ask is $3.30.  To assume a worst case scenario we will assume the position is entered with a market order at $3.30 (a real life trade might be wise to put in a limit order to buy at $3.15 or $3.20).

3Figure 3 – FXB Dec 154 Put (Courtesy www.OptionsAnalysis.com)

As you can see, one of two things will happen, either:

*FXB will fall and this trade will generate a substantial profit (percentage wise).

*FXB will not fall, in which case the trade will lose a maximum of $330.

A couple of notes:

*If FXB takes out the recent high of $156.04 a trader can consider getting out at that point.

*If FXB falls to its recent low the trade can make roughly $200.

*If FXB falls to the upper Elliott Wave projected range of 139.77 this trade can make over $1,000

Summary

This type of (“example” not “recommendation”) trade is “for speculators only.”  The primary reason is that it holds the potential to make a person feel very stupid very quickly.  All FXB has to do is rise a little bit to the upside and the whole basis for the trade (resistance near 154 and a bearish EW projection) collapses.

Still, opportunity is where you find it.

Jay Kaeppel

 

When NOT to Own Gold Stocks

Figuring out when to invest in gold stocks can be a pretty tricky proposition.  Especially when they are in a relentless bear market.  But figuring out when NOT to be in gold stocks may not be quite so tough.

For as it turns out there are some fairly consistent “unfavorable periods” for gold stocks on an annual basis.

Four Annual “Unfavorable Periods”

There are four times of year when gold stocks generally perform poorly – often even in a bull market.  They are:

*February Trading Day #14 through May Trading Day #1

*May Trading Day #15 through June Trading Day #9

*July Trading Day #1 through July Trading Day #19

*September Trading Day #21 through October Trading Day #19

What You Miss by Being Out of Gold Stocks During These Periods

Figure 1 displays the growth (OK, as it turns out “growth” may be a poor choice of words) of $1,000 invested in Fidelity Select Gold Sector fund (ticker FSAGX) only during the periods listed above starting on 12/31/1988 through August 14, 2015.1Figure 1 – Growth of $1,000 invested in FSAGX only during four “Unfavorable Periods” each year (12/31/1988-8/14/2015)

Let me sum up the results displayed in Figure 1 in a word – OUCH!!

Figure 2 displays the results on a calendar year basis. Column 2 displays the annual performance of gold stocks during all periods not listed above – i.e., essentially the “Non unfavorable periods”.  Column 3 displays the performance of gold stocks during all four periods listed above on an annual basis.

2

Figure 2 – Annual Results for “Non Unfavorable” and “Unfavorable” Periods

* – Annual Average calculated through 12/31/2014

For the record, note the annual results displayed in Figure 3: 1Figure 3 – Annualized Results

Now before anyone gets too excited please note that an investors holding FSAGX only during the “Non unfavorable periods” would have witnessed a loss of -28.8% in 2011 and a whopping hit of -50.4% in 2013.  So do not get the idea that “Non unfavorable” is the same as “Bullish.”

Remember that the real focus of this article is the “Unfavorable Periods” during which gold stocks lost about -98% over the course of 26 years – which kind of takes some doing.

Summary

Bad things can (and have) happened to gold stocks during “Non unfavorable periods”.   On the other hand, good things rarely ever happen to gold stocks during the “Unfavorable Periods” I listed earlier.

The bottom line:

*Do not assume that gold stocks will perform well when the calendar is not in one of the four unfavorable periods listed earlier.

*Do not expect gold stocks to perform well at all when the calendar is within one of the four unfavorable periods listed earlier.

In sum, the difference between:

*a gain of +4,584% (during all non unfavorable periods) and

*a loss of -97.9% (during all unfavorable periods)

…is what we “quantitative analyst types” refer to as “statistically significant.”

FYI: The next “Unfavorable period” for gold stocks begins at the close on 9/30/2015 and extends through the close on 10/27/2015.

Jay Kaeppel

About That ‘Inevitable/Calamitous’ Interest Rate Hike

It is pretty much impossible to read the financial press without hearing about the “inevitable” Fed rate increase.  And of course, “everyone knows that”,

a) the Fed will raise rates and that,

b) this will trigger [insert your worst fear here].

Now I am not making any predictions here myself.  I mean on the one hand, with short-term rates hovering around 0% and having done so for some time now, yes, a rise in interst rates does seem fairly inevitable at some point.  Still, having been around the block a time or two all I can say is that when “everyone knows” that Event A is sure to happen and that when it does then Event B is sure to follow, well, let’s just say that “things” have a way of not following the script.

Still, it might make sense to start thinking about a potential hike in interest rates.  So let’s look at one hypothetical play using options on ticker TBT, an ETF that trades the inverse of the long-term treasury bond times two (i.e., if the long-term treasury bond falls by 1% ticker TBT should rise roughly 2%).

0Figure 1 – Ticker TLT versus ticker TBT (Courtesy AIQ TradingExpert)

IMPORTANT NOTE: I am not offering what follows as a “recommendation”, only as an example of one, er, three ways to play.

Trade #1: Near-the-Money Bull Call Spread

The first trade is a close-to-the-money bull call spread buying the Dec 43 call and selling the Dec 48 call.1Figure 2 – TBT Dec 43-48 Bull Call Spread (Courtesy www.OptionsAnalysis.com)

2Figure 3 – TBT Dec 43-48 Bull Call Spread (Courtesy www.OptionsAnalysis.com)

The good news for this trade is that TBT needs only to rise 3%+ in order to exceed its breakeven price of $44.73.  The bad news is that the profit potential is capped at 189% even if rates (and by tension ticker TBT) were to rise substantially.

Trade #2: Far-Out-of-the-Money Bull Call Spread

The second trade is a far out-of-the-money bull call spread buying the Dec 54 call and selling the Dec 59 call.

3Figure 4 – TBT Dec 54-59 Bull Call Spread

4Figure 5 – TBT Dec 54-59 Bull Call Spread (Courtesy www.OptionsAnalysis.com)

The good news for this trade is that the profit potential is +1,900%.  The bad news is that the breakeven price (at December expiration) is 25% above the current price (although a rise in TBT in the near term might create a profit opportunity).

So from these two examples a trader has to either choose “Higher probability and lower profit potential” or “Lower probability and higher profit potential”.  But before “choosing” let’s look at one alternative.

Trade #3: Combining Near and Far Bull Call Spreads

This trade simply involves entering both trades simultaneously in a ratio of 6-to-1 (in other words buying 6 Dec 54-59 spreads for every 1 Dec 43-48 spreads purchased).

As you can see this creates a trade that has a reasonably obtainable breakeven price of $46.23 and substantial profit potential of +983%

5Figure 6 – TBT Dec 43-48 plus 54-59 Bull Call Spread (Courtesy www.OptionsAnalysis.com)

6Figure 7 – TBT Dec 43-48 plus 54-59 Bull Call Spread (Courtesy www.OptionsAnalysis.com)

Figure 8 compares the three trades.

Measure 43-48 Spread 54-59 Spread 43-48 + 54-59
Breakeven $44.73 (+3.1%) $54.25 (+25.1%) $46.23 (+6.6%)
Max Profit % +189% +1,900% +983%

Figure 8 – Breakeven and Profit Potential Comparisons

Summary

I feel the need to point out the fact that I am not necessarily claiming that right this very minute is the time to get bullish on TBT.  It’s been pretty weak for quite some time.  But, a) it is sort of near support (maybe) and, b) an interest rate hike is “inevitable” right?  (I mean “everyone knows” that – or at least so I am told…repeatedly, ad nauseum, day in and day out, thanks for the update, you can stop now thank you…..).

Also, I am not claiming that trades 1, 2 or 3 are actually great trades.  They are merely examples of limited dollar risk ways to play higher interest rates.  Trade 3 offers a tradeoff between reasonable probability (a 6.6% move in TBT is quite often child’s play) and outstanding potential profitability (+983%)

So there are three basic questions for any trader to ask and answer:

1) Will interest rates rise?

2) If rates will rise, how soon will they rise?

3) If rates will rise, how far will they rise?

Depending on your own answers to these questions, the proper course of action for you might be to:

a) Buy a near-the-money bull call spread on TBT

b) Buy a far-out-of-the-money bull call spread on TBT

c) Combine to spread as shown in Figures 5 and 6

d) Take no action at all

Choose wisely.

Jay Kaeppel

 

I’m Back on Land…and On-Line

Hello again.  The family and I went on a Caribbean cruise the first week of August.  Now if you happen to live in the Southeastern U.S. you may be thinking “A Caribbean cruise in August…..are you crazy?”  as this is the start of hurricane season.  Hey, I’m a speculator…and the price was right.

Bottom line: We had a great time and the weather was great!  More to the point I decided to “unplug” for the week.  Oh, I did manage to check the markets a couple of times but that was it.  After some early “withdrawal symptoms” I “sailed” (har) through the rest of the week.

Following up on these articles I did notice that:

a) Some of the major stock market indexes have dropped below their 200-day moving averages (while others did not);

b) AAPL took out support at $119.22 and fell as low as $112.10 before bouncing…er, sort of, and;

c) The British Pound (ticker FXB) crept lower.

Have to get back up to speed on things and hopefully I can think of something reasonably intelligent to say about the state of the markets in the next several days.

Jay Kaeppel