In this article titled “World, Meet Resistance” – dated 12/21/2017 – I noted the fact that many single country ETFs and regional indexes were closing in on a serious level of potential resistance.  I also laid out three potential scenarios.  So what happened?  A fourth scenario not among the three I wrote about (Which really pisses me off.  But never mind about that right now).

As we will see in a moment what happened was:

*(Pretty much) Everything broke out above significant resistance

*Everything then reversed back below significant resistance.

World Markets in Motion

Figure 1 displays the index I follow which includes 33 single-country ETFs. As you can see, in January it broke out sharply above multi-year resistance. Just when it looked like the index was going to challenge the all-time high the markets reversed and then plunged back below the recently pierced resistance level.

(click to enlarge)Figure 1 – Jay’s World Index broke out in January, fell back  below resistance in February (Courtesy AIQ TradingExpert)

The same scenario holds true for the four regional indexes I follow – The Americas, Europe, Asia/Pacific and the Middle East – as seen in Figure 2.

(click to enlarge)Figure 2 – Jay’s Regional Index all broke above resistance, then failed (Courtesy AIQ TradingExpert)

So where to from here?  Well I could lay out a list of potential scenarios. Of course if history is a guide what will follow will be a scenario I did not include (Which really pisses me off.  But never mind about that right now).

So I will simply make a subjective observation based on many years of observation.  The world markets may turn the tide again and propel themselves back to the upside.  But historically, when a stock, commodity or index tries to pierce a significant resistance level and then fails to follow through, it typically takes some time to rebuild a base before another retest of that resistance level unfolds.

Here’s hoping I’m wrong

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The question on many investors’ minds is “are we in a bond bear market?”  Given that long-term treasuries have lost roughly 17% since July of 2016 it is a fair question.

The main model that I use is still bearish on bonds (more on this topic below).  Still, there are a few potential “lights at the end of the bond tunnel” – at least potentially in the near-term.

Long-Term Rates

My mega long-term “fail-safe” bond trend indicator appears in Figure 1.  It is the yield on 30 year treasuries (ticker TYX – which is multiplied by 10 for some unknown reason) with a 120-month exponential moving average.

Figure 1 – 30-Yr. Treasury yields (Ticker TYX) with 120-month average (Courtesy AIQ TradingExpert)

When the day comes that TYX breaks out above the 120-month moving average I for one will officially designate the great bond bull market as “over.”  And that day is coming.  But for what it’s worth – it’s not quite here yet.

Metals Positive for Bonds

In this article I wrote about a bond timing model that uses the relationship between gold and copper.  Like a lot of timing models of all stripes it does a good job of differentiating good times for bonds from bad times for bonds, but is very far from perfect.

It goes like this:

A = Gold / Copper

B = 30-day moving average of A

C = 80-day moving average of A

D = B – C

If D > 0 = Bullish for bonds*

If D < 0 = Bearish for bonds*

*- with a 1-day lag

This indicator flipped to bullish at the close on 2/7/18 after being bearish since 7/10/2017.

Figure 2 displays the action of ticker TLT since the last “sell” signal in July 2017.  As you can see, in the end it ended up being “correct” as TLT was lower on 2/7/18 than it was on 7/10/17.  But that was not the case until the last week or so.  So for most of the time during this bearish period TLT traded higher. Figure 2 – Ticker TLT with recent Jay’s Metal Model signals (Courtesy AIQ TradingExpert)

What is most important however is to focus on the long-term results. In Figure 2 the blue line depicts the growth of equity achieved by holding long 1 t-bond futures contract ONLY when the model is bullish while the red line depicts the growth of equity achieved by holding long 1 t-bonds futures contract ONLY when the model is bearish (red line).

Figure 2 – T-bond futures $ gain/loss when Jay’s Metal Model is bullish (blue line) versus when model is bearish (red line)

The long-term difference in performance is fairly obvious.  That being said it should also be noted that the blue line is by no means a series of straight line advances, i.e., there is no guarantee that this latest bullish signal will prove fortuitous, especially given that we may be transitioning from a long-term bond bull market to a long-term bond near market.

One More Possible Piece of Good News

In this article I applied an indicator I originally learned from Tom McClellan at http://www.mcoscillator.com to weekly TLT.  This indicator looks at the number of times TLT has been up minus the number of times down over the past 20 weeks. Very often a drop to -2 or below followed by an upside reversal of 2 points (i.e., it drops to -2 then subsequently rises to 0, or drops to -3 then rises to -1 and so on) has presaged a favorable up move in bonds. This indicator applied to TLT recently fell to -2 and may flash a favorable signal soon (please note that it HAS NOT given a buy signal yet and that it  could take several weeks before it does).

Figure 3 – Weekly TLT with UpDays20 Indicator (Courtesy AIQ TradingExpert)

One Piece of “Still Bad News”

In this article I wrote about one of the main bond models I use that uses the trend in Japanese stocks to trade bonds inversely, i.e., if Japanese stocks are bearish it is bullish for bonds and vice versa. I use a 5-week and 30-week moving average to quantify Japanese stocks as “bullish” or “bearish”.

In Figure 4 when the blue line in the top clip is above the red line this is considered bearish for bonds and when the blue line is below the red line it is considered bullish for bonds. For now the blue 5-week average line is still well above the red 30-week average, so this indicator still  designates the trend for bonds as “bearish”.

Figure 4 – Ticker TLT tends to trade inversely to ticker EWJ (Courtesy AIQ TradingExpert)

Summary

So are bonds due to rally?  Well, it seems like at least a short-term bounce could be in the offing.  That being said, with bonds breaking down sharply at the moment, 1) this “idea” is geared for “traders” who are not afraid of (and are unacquainted with) taking risks, 2) it might make sense to wait for the UpDays20 indicator discussed above to tick higher by two points – which could take up to several weeks to play out – before “taking the plunge.”

As always I am not “recommending” anything, just highlighting what I see.  For longer-term investors the “Boring Bond Index” bond strategy I wrote about here remains a viable  long-term approach to bond investing.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The one trait among investors that is most “everlasting” is the tendency to extrapolate current trends ad infinitum into the future.  Until very recently, an entire generation of investors has no idea what a bond bear market looks like – or how to prepare or react for that matter.  Despite the fact that interest rates have demonstrated a tendency to rise and fall in roughly 30 year waves, too many investors have never given much thought to the possibility that rates might rise again someday even though rates had been declining steadily since the early 1980’s.

And don’t even get me started on the stock market.  The stock market had been on such an unprecedented run (the longest in history without so much as a 3% pullback) until recently that it seemed that no one wanted to even raise the possibility that the market could do anything other than rise indefinitely.  Never mind that the stock market by many measures is (or at least was) as overvalued as before the 1929 crash and the 2000 dot com bubble.  It is OK to be upset about the recent action in the stock market. It is OK to wonder if this is simply a pullback in a larger ongoing uptrend or the beginning of something much worse.  But if you are absolutely stunned that the stock market declined with a bit of ferocity – I hope I am not being indelicate but – WAKE UP! You need to set aside sometime to peruse a 100-year stock market chart and reacquaint yourself with the reality that “the market fluctuates.”

A lot.

Commodities Rising?

Another “thing” that “everybody knows” – or more accurately has become conditioned to believe – is that “stocks are investments” and that commodities are for the “inflation whackos.”  The problem of course is that “everybody” doesn’t know squat.

Figure 1 displays a very enlightening chart that displays the ratio between the Goldman Sachs Commodity Index (GSCI) and the S&P 500 Index (SPX). As you can see this ratio clearly “goes to extremes”.  And does so  on a fairly regular basis.  For a period of years commodities vastly outperform stocks and the ratio rises to a peak, and then everything turns and stocks outperform commodities for years at a time.  Forgetting even trying to actually time these swings for the moment, note the current reading.

Figure 1 – GSCI Commodity Index / S&P 500 Ratio (i.e., Commodities versus Stocks)

Will the average investor end up being caught completely unaware if commodities vastly outperform stocks over the next 3 to 8 years?  I have to believe the answer is “Yes”.  But given the extreme recent reading in the GSCI/SPX Ratio I for one am pretty confident that that will be the case.

To better understand the Yinn and Yang nature of commodities versus stocks (i.e., hard assets versus paper assets) consider the results in Figure 2 which displays the performance of the GSCI Commodity Index and the S&P 500 between the peaks and troughs in the GSCI/SPX Ratio highlighted in Figure 1.          Figure 2 – % Gain/Loss for GSCI Index and S&P 500 Index during various “Trough to Peak” and “Peak to Trough” movements in the GSCI/SPX Ratio

During the 4 “Green trough to Red peak” periods in Figure 1:

*GSCI Index average gain = +289.7%

*S&P 500 Index average gain = +12.4%

During the 4 “Red peak” to “Green trough” periods in Figure 1:

*GSCI Index average loss = (-35.4%)

*S&P 500 Index average gain = +117.3%

Being in the right asset class at the right time clearly makes a difference.

For the record, I am NOT “recommending” commodities.  I am simply highlighting the historical back and forth between hard assets and paper assets and the current extreme nature of that relationship.

Also for the record, it is possible to own commodities without trading commodity futures via  the use of  ETFs.  For those interested in exploring further, tickers DBC, GSG and RJI may merit a closer look.  These ETFs got crushed between 2008 and 2016, have since rallied sharply and may now actually be a bit overextended.

Summary

So are stocks finished?  Is it time to pile into commodities and hard assets?  The truth is that it is impossible to identify the exact moment that “the turn” occurs.  Still, given the history displayed in Figure 2 and the extreme low recent reading in the GSCI/SPX ratio that appears at the lower right in Figure 1, now might be exactly the time to at least start envisioning an investment future that is significantly different from the current one that “everybody knows”.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

I am as guilty as anyone of overanalyzing the markets on a regular basis. Luckily there is a tiny corner of my brain that constantly reminds me that it doesn’t necessarily have to be that way.

This article will illustrate this point by expanding on something I wrote about regarding retailing stocks in this article.

The Retailing Annual System (RAS)

For our test we will use the following:

*Ticker FSRPX (Fidelity Select Retailing Sector fund)

*1-3 Year Treasury Index (Bloomberg Barclays Treasury 1-3 Yr. Index)

*We will hold FSRPX during the months of February March, April, May, November and December

*During all other months we will hold short-term treasuries

Figure 1 displays the growth of $1,000 for the “system” above (blue line) versus buying and holding FSRPX (red line) since April 1986.Figure 1 – Growth of $1,000 invested using Jay’s RAS (blue) versus buying and holding FSRPX (red); 4/1986 through 12/2017

For the record:

*The average 12-month % gain was +17.2%

*The median 12-month % gain was +14.0%

*The largest 12-month decline was -13.0%

*The largest drawdown was -15.3%

*The System has had 30 Up Calendar Years

*The System has had 2 Down Calendar Years (-3.9% in 1994 and -0.2% in 2008)

Figure 2 displays the calendar years performance year-by-year.

Figure 2 – Year-by-Year Results for Jay’s RAS

Summary

Does investing in just one sector for six months out of every calendar year (and holding short-term treasuries the rest of the time) really qualify as a “System”?  Does it really matter?  The numbers are what they are. One investor may consider this a viable approach to investing and another may not.

The point remains….when it comes to investing in the financial markets, it doesn’t necessarily have to be complicated in order to work.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

There is an asset class (I think you can call it that) that I have been intrigued with for some time now but have never written about.  There are three primary reasons for this.

*First, I’ve never actually invested there

*Second, I can’t decide if investing there is a good idea or not

*Third, I don’t want anyone to read my writing about them and toassume that  I am necessarily endorsing or recommending them.

So what is the source of all this angst?  Leveraged, high yield ETFs.

Leveraged, High Yield ETFs (heretofore LHYE)

First, here is what we are talking about: Leveraged high yield ETF are just what they sound like.  They hold high yield securities (of varying types depending on the fund, however, many of them invest in closed-end funds, which can trade at a discount to their net asset value) and buy them using leverage.  There is good news and bad news.

The good news is that the yields are terrific (up to 18% or more).

The bad news is twofold:

1. There are risks involved

2. I can’t quite figure out just how risky they are (but fear that they are much riskier than even I realize)

Figure 1 displays a list of a variety of LHYEs from an article by “Stanford Chemist” posted on SeekingAlpha.com.  For more in depth information on one of the ETFs see this article by Lance Brofman.Figure 1 – A listing of various Leveraged High Yield ETFs (SeekingAlpha.com)

As you can see in Figure 1, there are some terrific yields offered. Some people who are getting 2% to 3% yield on their current investments might look at these yields and say, “Wow, this is great”.  Others will look at them and say “This looks too good to be true.”  So who’s right? The problem is that I don’t really know.  But I do know that there is risk.  Consider the charts in Figure 2.Figure 2 – Price Charts for several Leveraged High Yield ETFs (Courtesy ProfitSource by HUBB)

As you can see in Figure 2, each of these LHYEs had significant price declines somewhere along the way.  An 18% yield looks great – right up until the point where price declines 40% to 60%. Then suddenly, that 18% yield doesn’t look so good anymore.

So what happens in a true stock bear market?  I’m not sure. What about a bond bear market?  Same answer. So the bottom line is that there is plenty of cause for caution and concern.  Still, there is the other side of the coin.

Figure 3 displays 11 LYHEs that will be included in an index in Figure 4.

Figure 3 – 11 Leveraged High Yield ETFs used to create an Index

Figure 4 displays the total return growth for the 11 LHYEs displayed in Figure 3 versus buying and holding the S&P 500 Index starting on 5/31/2012.Figure 4 – Growth of $1,000 invested in 11 Leveraged High Yield ETFs (blue line) versus $1,000 invested in the S&P 500 Index; 5/31/2012-12/31/2017

*The good news is that while the stock market has had a pretty good run (+130%) since 5/31/2012, the total return for a portfolio comprised of the 11 LHYE’s listed in Figure 3 gained quite a bit more (+180%) during the same period.

*The bad news is that while the worst drawdown for SPX (using month-end total return data) was -8.4% the LHYE Index endured a -24.3% drawdown between then end of February 2015 and the end of January 2016.

So again, this leads me to wonder: How bad do things get in a true bear market for stocks and/or bonds?

Because I can’t answer that question I remain a bit gun shy. So is there something that can be done to mitigate risk a bit? Let’s look at one possibility.

Using Moving Averages to Filter for Trend

Figure 5 displays a price chart of our LHYE Index components along with a 10-month and 21-month simple moving average.Figure 5 – Jay’s LHYE Index (Courtesy AIQ TradingExpert)

For our purposes, a “sell” signal occurs when the Index closes two conseivutive months below the 21-month moving average and a
“buy” signal occurs when the Index closes 1 month back above the 10 month moving average.

*During “Buy signals” we will hold the index of 11 LHYEs (using monthly total return data).

*During “Sell signals” we will hold short-term treasuries (using Bloomberg Barclays Treasury 1-3 Yr. total return data)

Using the method just descrbied generates the “LHYE System” equity curve (blue line) displayed in Figure 6, versus buying-and-holding the S&P 500 Index (red line).

Figure 6 – Growth of $1,000 invested invested using Jay’s LHYE System (blue line) versus SPX buy-and-hold (red line); May 2012-present

The blue line in Figure 6 represents a 21.2% average 12-month return with a maximum drawdown (using monthly data) of -13.9%.

Summary

So a lot of questions remain.  For example:

*Some readers might be asking “what the heck exactly is a leverage high yield ETF again?”  Answer: You should explore further before even giving a thought to investing in them.

*Some readers might be asking “Just exactly how risky are these things?” As far as I can tell the answer to that question is “Very” (see Figure 2 again).  Beyond that – given their limited history – it is hard to tell

*Others might ask: “Does the moving average filter used in Figure 6 reduce risk enough to justify taking the plunge?”  Answer: It’s hard to say.  Waiting for two monthly closes below a 21-month moving average works well in a standard issue, “stop advancing, churn sideways to lower for awhile, then start to breakdown” bull market to bear market transition.  In a market crash, not so much.

So there you have it.  The bottom line is that my job here is not to “tell you what to do”, but to simply “tell you what I see.”  With Leveraged, high-yield ETFs I see lots of market beating potential –and lots of risk.

Over to you…..

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The U.S. Dollar (USD) is getting a lot of attention these days, and not in a good way.  If you look at the chart in Figure 1, it would appear that the answer to the question posed in the headline is pretty obvious.Figure 1 – US is clearly breaking down…… (Courtesy ProfitSource by HUBB)

(See also Time to Adjust FXE and USO Positions?)

One can look at Figure 1 and pretty easily conclude “Breakdown”.  And they may be right.  But sometimes a little perspective can offer a view in a different light.

Figure 2 is a longer-term chart and seems to suggest that USD is heading smack  dab into what has historically been “the scrum zone” (for lack of a better term) for the dollar.

Figure 2 – …..or is it? (Courtesy ProfitSource by HUBB)

As you can see the USD has a long history of bouncing around at or near its current level.  What happens from here?  Let’s add one more interesting (OK, “interesting” might be a little strong, but hey I’m a market geek) item.  The charts in Figure 3 were posted on Twitter by renowned trader Peter Brandt and displays sentiment among two different groups of traders.  If you look closely you will note that both readings are at extreme levels that historically have been followed by reversals in the dollar.Figure 3 – US Dollar sentiment as a contrary indicator (pointing to a reversal?) (Courtesy: Peter Brandt)

(See also Time to Adjust FXE and USO Positions?)

Summary

So which way the dollar?  Have to go with my standard response – “It beats me.”  But the key things to note are:

1) Don’t necessarily buy the idea that the “dollar is dead”

2) Recognize that whatever happens in the USD wil have a big impact on currencies, metals and energies, particularly crude oil.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

In recent articles I wrote about “example” trades in the Euro (using ETF ticker FXE) and crude oil (using ETF ticker USO).  Given the state of the US Dollar it might be time to look at adjusting those positions.

The Euro (ticker FXE)

In this article I highlighted an “example” trade for FXE using the “backpread” strategy.

Figure 1 displays the original position form the original article.Figure 1 – Original FXE risk curves (Courtesy www.OptionsAnalysis.com)

Figure 2 displays the position updated through 1/24/18. Figure 2 – Original FXE position as of 1/24/2018 (Courtesy www.OptionsAnalysis.com)

Figure 3 displays one possible adjustment.Figure 3 – FXE position adjustments (Courtesy www.OptionsAnalysis.com)

Figure 4 displays the risk curves for the adjusted positionFigure 4 – Risk curves for adjusted FXE position (Courtesy www.OptionsAnalysis.com)

The key thing to note is that after the adjustment the remaining position still enjoys unlimited profit potential and the “worst case scenario” is a profit of +$766.

Crude Oil (ticker USO)

In this article I highlighted an “example” trade for USO using the “backpread” strategy.Figure 5 – Original USO risk curves (Courtesy www.OptionsAnalysis.com)

Figure 6 displays the position updated through 1/24/18.

Figure 6 – Original USO position as of 1/24/2018 (Courtesy www.OptionsAnalysis.com)

Figure 7 displays one possible adjustment.Figure 7 – USO position adjustments (Courtesy www.OptionsAnalysis.com)

Figure 4 displays the risk curves for the adjusted positionFigure 4 – Risk curves for adjusted USO position (Courtesy www.OptionsAnalysis.com)

The key thing to note is that after the adjustment the remaining position still enjoys unlimited profit potential and the “worst case scenario” is a profit of +$530.

(See also U.S. Dollar – Breakdown or Bear Trap?)

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

A lot of trades get made based on earnings.  Some investors buy (or sell short) shares in anticipation of strongly higher (or lower) earnings announcements.  Some option traders try to play both sides by buying a straddle (i.e., buy a call and a put option in hopes that the underlying shares will move significantly in one direction or the other) and hope that the gain on the profitable side will be larger than the loss on the other side.

Today I will highlight “third way.”  It definitely qualifies as something of a “special situation” and an option strategy that in all candor is typically best avoided.

The Reverse Calendar Spread

A standard calendar spread involves buying a call or put option at a given strike price in a farther out expiration month and selling a call or put option at the same strike price in a closer expiration month.  The hope is that the underlying security will remain within a particular price range and a profit will ensue as the shorter term option loses time premium faster than the longer-term option.  An example of a standard calendar spread appears in Figure 1.Figure 1 – Standard calendar spread risk curves(Courtesy www.OptionsAnalysis.com)

As you might guess, the Reverse Calendar Spread is entered by doing the opposite – buying the shorter term option and selling the longer term.  Why would someone do this?  Is this even a good idea? The candid answer is “it depends”.  In reality, this strategy should only be used under certain circumstances.

Like what? I thought you’d never ask.

To profit using this strategy two catalysts need to be in place:

1. A reason to believe the underlying security will make a move

2. Extremely high implied volatility and some expectation that volatility will decline during the course of the trade

Enter Under Armor

First off – as always – what follows is NOT a “recommendation”, but merely an “example”.

Before proceeding, a quick lesson in implied volatility.  In Figure 2 we see a bar chart for ticker UA along with the implied volatility for 90+ day UA options.  You don’t have to be an expert to recognize that implied volatility is at an extremely high level.Figure 2 – Ticker UA with implied option volatility at record highs  (Courtesy www.OptionsAnalysis.com)

Why does this matter? Two things to keep in mind.

1. IV tells us relatively how much time premium is built into the price of the options on a given security. So Figure 1 tells us that UA options are “expensive”.

2. Longer-term options will gain or lose much more time premium than shorter-term options based on changes in IV.

OK, now to our example trade:

*Buy 1 UA Apr2018 12.5 put

*Sell 1 UA Jan2019 12.5 put

Figure 3 displays the particulars of the trade.  Note the “Vega” figure of -$2.51 in the upper right.  A quick explanation.  Vega is a Greek term that tells us how much (in dollars) this position will gain or lose if implied volatility rises by one percentage point.  So in this case we see that IV rises even higher from here that will hurt this trade since Vega is negative.  However, this trade is a bet on sharply lower IV going forward.  In other words the impetus for the trade is the hope that after earnings are announced the implied volatile for UA options will collapse back down into the normal range.

In this case, if IV fell 10 full percentage points it would generate $25.10 in profit in this trade (-$2.51 x -10 points = +$25.10).  Are we having fun yet?Figure 3 – UA Reverse Calendar Spread particulars  (Courtesy www.OptionsAnalysis.com)

Figure 4 displays the risk curves for the trade at the time the trade is entered.  Note that these curves are not terribly impressive on the face of it, as it would appear that a significant price move is required to generate a profit.  Of course, the other catalyst for the trade is the belief that the stock price may jump or fall significantly when earnings are announced.Figure 4 – UA Reverse Calendar Spread initial risk curves (Courtesy www.OptionsAnalysis.com)

Now let’s look at what might happen if in fact we are correct and that

1. Implied volatility collapse after earnings are announced, and/or;

2. Price makes a significant jump or fall

We are hoping for a “quick” profit – i.e., earnings are announced and a) and/or b) above occur, we take our profit and move on. However, if that does not happen, because the option we are buying expire in April we could hang on for awhile if necessary to see if IV will eventually subside.

Still, because time decay works against this trade in the last 30 days we will assume that we will not hold this position during the last 30 days before July expiration.

To test these possibilities, in Optionsanalysis.com we will adjust the settings for this position as shown in Figure 5 – i.e., we will assume as 30% decline in IV (done by setting the multiplier to 0.70) and we will set the last date for the risk curve to 30 days before July expiration.

Figure 5 – Adjusting IV levels in OptionsAnalysis (Courtesy www.OptionsAnalysis.com)

If in fact IV declines by 30%, our risk curves for this position will resemble those displayed in Figure 6.Figure 6 – UA Reverse Calendar Spread risk curves if IV falls 30% from current record high levels (Courtesy www.OptionsAnalysis.com)

What we see is the decline in volatility causes the January2019 call option that we are short to give up a lot of its time premium.  As you can see, under this scenario this trade would be profitable at any price. Also, the further the price of UA moves the more profitable the trade.

Summary

As always, I need to emphasize again that I am not “recommending” this trade.  I am simply using it to illustrate “one way” to trade based on a given set of circumstances. To recap:

*A company will soon be announcing earnings

*Speculation about those earnings has driven implied option volatility to exorbitant levels

*We are willing to risk a certain amount of money that when earnings are announced the price of the stock will move significantly, and/or implied volatility to decline significantly.

Ironically, under most circumstance the Reverse Calendar Spread is not an attractive choice of strategy.  But as you have seen, under the right circumstances – and assuming of course that any of our assumptions actually play out – it can offer some interesting potential.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

There is a lot of hand-wringing going on these days regarding the bond market.  And rightly so given that interest rates have been (were?) in a downtrend for 35+ years.  Given that, given the long-term cyclical nature of interest rates and given that rates are at a generational low level, “concern” is understandable.

However, needless hand-wringing over events that have yet to occur is not.

Figure 1 – Long-term treasury yields through the years (Courtesy: ObservationsanNotes.blogspot.com)

(The chart in Figure 1 is updated only through about 2012.  Nevertheless, it effectively highlight the long-term cyclical nature of interest rates.)

The problem is the “well, interest rates are destined to rise therefore I should immediately [fill in your defensive action here].”

Many analysts and investors are following and attempting to interpret every tick in bond yields.  In fact, some very well known bond “people” have proclaimed a “bond bear market”.  And they may be right.  But still…

What I Follow in the Bond Market

What follows are a few random thoughts on some of the things I look at when tracking the bond market.

#1. 30-Year Yield versus 120-month Exponential Moving Average

Figure 2 displays ticker TYX, an index which tracks the yields on 30-year bonds (for some reason it multiplies by 10 – so a yield of 3% appears on the chart as 30.00).Figure 2 – 30-year treasury yields versus 120-month exponential moving average (Courtesy AIQ TradingExpert)

Using the data from Figure 1 I have found that a 120-month (i.e., 10-year) average does a pretty good job of riding the major trends in interest rates.  As you can clearly see in Figure 2, TYX is still noticeably below its 120-month EMA.  This could obviously change quickly but  for the moment by this objective measure the long-term trend in interest rates right at this very moment is still “down.”

Please note that I am not saying that interest rates will not rise and move above this MA.  I am saying two things:

1. Until the crossover occurs try not to focus too much attention on dire predictions.

2. Once the crossover does occur the bond market environment that most of us have known throughout all or most of our investment lives will change dramatically (more on this topic when the time is right).

#2.  The Yield Curve(s)

Figure 3 displays the yield curves for 30-year yields minus 10-year yields and 10-year yields minus 2-year yields. The narrowing trend is obvious. This is causing great consternation because historically when the yield curve “inverts” (i.e., when shorter-term rates are higher than longer-term rates) it is a very bad sign for the economy and the financial markets.Figure 3 – 10-yr yield minus 2-year yield (blue) and 30-year yield minus 10-year yield (orange); (Courtesy: YCharts)

The problem here is that there is still an important difference between “narrowing” and actual “inverting”.  Many people seems to look at Figure 3 and assume that an inverted yield curve (i.e., if and when these lines go into negative territory) is “inevitable” and that things are therefore doomed to get worse for the economy and the markets.

Repeating now: There is still an important difference between a “narrowing” yield curve and an actual “inverted” yield curve.  Until the yield curve actually does invert try not to focus too much attention on dire predictions.

#3. The Current Trend in Bonds

One trend following indicator that I follow (and have written about in the past) is the inverse relationship between long-term t-bonds and Japanese stocks.  Figure 4 display ticker EWJ (an ETF that tracks an index of Japanese stocks) versus ticker TLT (an ETF that tracks the long-term treasury bond).

Figure 4 – Ticker EWJ versus Ticker TLT (Courtesy AIQ TradingExpert)

Figure 5 displays two equity curves.  The blue line represents the $ gain achieved by holding long 1 treasury bond futures contract ONLY when the EWJ 5-week moving average is below the EWJ 30-wek moving average and the red line represents the $ loss achieved by holding long 1 treasury bond futures contract ONLY when the EWJ 5-week moving average is above the EWJ 30-week moving average. Figure 5 – Holding long t-bond futures when EWJ is in a downtrend (blue line) versus holding long t-bond futures when EWJ is in an uptrend (red line); December 2003-present

Notice anything different about  the blue line versus the red line?  With EWJ trending strongly higher, caution remains in order or the long-term treasury bond. If the trend in EWJ reverses things may look better for long-term bonds.

#4. Short and Intermediate Term Bonds remain a Viable Alternative

As I wrote about here an index of short and intermediate treasury and high grade corporate remains a viable long-term approach for income investors. Figure 6 displays the growth of $1,000 invested using the “Boring Bond Index” I wrote about in the aforementioned article.  This index has gained in 38 of the past 42 years.Figure 6 – Growth of $1,000 invested using “Boring Bond Index” Method; 12/31/1975-11/30/2017

Summary

There are good reasons to be wary of interest rates and bonds. At the same time overreacting to dire headlines also remains a very poor approach to investing.

So in sum:

*The very long-term trend in interest rate is still technically “down”

*The yield curve is narrowing but still has a ways to go before it inverts

*The current trend in long-term bonds is bearish

*Short and intermediate term bonds experience much less volatility than long-term bonds (and reinvest more frequently, which may come in handy if rates do begin to  rise in earnest).

*If and when TYX pierces its long-term average and/or when the yield curve inverts, the time will arrive for investors to make some wholesale changes in how they approach their bond market investments.

*If and when EWJ starts to fall, things may improve for the current plight of the long-term treasury.

*And through it all, a boring approach to bonds may still prove very useful.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

In this article I detailed an indicator I refer to as VixRSI14 using monthly charts. Today let’s apply the same method to weekly bar charts.  Before we do that a quick look at how this indicator functions.

VixRSI combines two indicators – Larry William’s VixFix and Welles Wilder’s Relative Strength Index (RSI).  In Figure 1 you see a weekly bar chart for YHOO.  Notice that as price declines the VixFix indicator rises and RSI falls. VixRSI14 essentially measures the difference between the two and looks for extremes as a sign of a potential reversal. See Figure 5 for YHOO with VixRSI14.

Figure 1 – YHOO with Williams VixFix (with 3-day exponential smoothing) and Wilder’s 14-period RSI (Courtesy AIQ TradingExpert)

The Weekly Version of VixRSI14

We will use the same method I described in the previous article, i.e.:

*We will calculate the VixRSI14 indicator (see code at end of article) on a weekly basis

*A “buy alert” occurs when VixRSI14 drops below 3.00 after first rising to 3.50 or higher

Once again, please note that:

*There is nothing magic about 3.50 or 3.00

*Not every “buy alert” is followed by an immediate rally (or even any rally at all for that matter)

*Any actually trading”results” will depend heavily on what you trade, how much of it you trade, when you actually get in, when you get out with a profit and/or when you get out with a loss.

*This VixRSI14 alert signal is simply serving notice that a given security may be overdone on the downside and may be ready soon to reverse to the upside.  Nothing more, nothing less.Figure 2 – AAPL

Figure 3 – AXP

Figure 4 – IP (Courtesy AIQ TradingExpert)

Figure 5 – YHOO (Courtesy AIQ TradingExpert)

Summary

In 2018 I intend to try to share a few more trading “ideas” that maybe are not quite “finished products”.  VixRSI14 fits neatly into the “Idea” category. Sometimes the alerts are early.  Sometimes the alerts are late.  Sometime the alerts don’t really pan out at all.  Sometimes alerts are followed by one more sharp decline which is then followed by a major rally. So maybe some sort of trend reversal confirmation would be helpful.  I don’t know.

Hey, that gives me an idea….

Code:

William’s VixFix is simply the 22-period high price minus today’s low price divided by the 22-day period price (I then multiply by 100 and then add 50).  That may sound complicated but it is not.

The code for AIQ TradingExpert appears below.

########## VixFix Code #############

hivalclose is hival([close],22).

vixfix is (((hivalclose-[low])/hivalclose)*100)+50.

###############################

####### 14-period RSI Code ###########

Define periods14 27.

U14 is [close]-val([close],1).

D14 is val([close],1)-[close].

AvgU14 is ExpAvg(iff(U14>0,U14,0),periods14).

AvgD14 is ExpAvg(iff(D14>=0,D14,0),periods14).

RSI14 is 100-(100/(1+(AvgU14/AvgD14))).

###############################

VixRSI14 is then calculated by dividing the 3-period exponential average of VixFix by the 3-period exponential average of RSI14

####### VixRSI14 Code ###########

VixRSI14 is expavg(vixfix,3)/expavg(RSI14,3).

###############################

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.