You might ask – why emphasize that this is a “brief” update on soybeans?  A show of hands….how many of you would like to read an extended update on soybeans?

That’s what I thought, and hence the emphasis on the word “brief.”

In any event, as I wrote about here, soybeans have showed a seriously unfavorable seasonal trend during most of July into late August (down 30 times in the last 37 years).  The bad news with any seasonal trend is always the fact that there is never any guarantee that it will work “this time around.”

On the other hand, noteworthy seasonal trends only become noteworthy because they are right more often than not.  Plus – as I discussed in the original article – the “bad news for beans in July” theory makes intuitive sense simply because by mid-July traders typically have a pretty good idea of whether or not it will be a good year for soybeans crops. In addition, even in a bad year for bean crops (which equates to higher bean prices due to lower supply – you do remember that whole “supply and demand thing” right?), most of the “fear buying” and hedging has already been done by mid-July and as a result the “risk premium” tends to come out of bean prices to some extent even in a bad year for bean crops. So bean prices have a tendency to be “weak” from July Trading Day #9 through August Trading Day #6.

And some years bean price just simply fall apart.  Like this year for example.

Figure 1 displays the November soybean futures contract starting at the end of July Trading Day #9 when it closed at 1025 (each point represents $50; also for the record a price of 1025 represents a price of $10.25 per bushel of soybeans).  In the nine trading days since beans have plummeted to 933.25.  This represents an open profit of $4,587.50 per futures contract.Figure 1 – Unfavorable Seasonal period for Soybeans looking, um, unfavorable indeed (Courtesy: www.Barchart.com)

If a trader is holding a short position in any size greater than a 1-lot I would suggest saying “Thank You” to the market Gods and taking some profits right here.  Whether beans will be higher or lower by the end of August Trading Day #6 (the end of the unfavorable seasonal period) is anyone’s guess.  But quick and easy profits don’t come along all that often.

Certainly not often enough.  Can I get an “Amen?”

Jay Kaeppel

A while back I wrote about the potential for crude oil to decline in price – based on nothing but daily and weekly Elliott Wave counts.  As this is an approach that may or may not inspire a lot of confidence (depending primarily on the level to which one is or is not an “Elliotthead”), I highlighted an example “limited risk” way to play (i.e., buying put options).  Please not that I did not say “low risk”, only limited risk.

Yes, there is a difference.  Just to clarify, I refer to buying call or put options as “limited risk” and not “low risk” for the following reason: It is common to hear purveyors of option trading tout the fact that when buying options “you can only lose what you put up.”  Which sounds at first like a positive (and is as far as it offers the aforementioned “limited risk”)?  However, a corollary – and far less positive sounding – way to phrase it is to say “you can only lose 100% of your investment.”

Wait, what?

Precisely.  If you buy a call or put option and it expires worthless you lose 100% of what you put up.  Somehow a loss of 100% and the phrase “low risk” just doesn’t quite compute in my poor addled mind.  But I digress.

The Original Trade

As detailed in the original article the original trade involved buying 70 USO August 15 puts on 5/13 at $0.14 for a total cost and total maximum risk of $980.  Well, things worked out OK.

This trade was adjusted on 7/7 by selling 40 of the 70 puts.  This left a long position of 30 puts and locked in a minimum profit of $140.  Well crude oil continues to tank which is all well and good for this trade.  However, as August expiration draws closer time decay can an extract a heavy toll on this position.

As you can see in Figure 1 and 2 (which displays the expected profit or loss for this trade based on USO price, with each line represented the expected P&L as of a specific day).  Much of the current open profit may just wither away unless USO falls well below $15 a share.  There are only 25 days left until August expiration and Theta (the Greek value denoting how much the trade will lose in one day based solely on time decay) is -$35.Figure 1 – Original Trade Adjustment  (Courtesy www.OptionsAnalysis.com)

Figure 2 – Time decay is a danger between now and August expiration  (Courtesy www.OptionsAnalysis.com)

So it seems like time to “do something.” As always, one could just sell the 30 remaining contracts and take a pretty decent profit.  However, as you can see in Figure 3, the Elliott Wave count is still pointing to potentially lower prices for USO.  So it could make sense to extend this trade.

Figure  3 – Elliott Wave still projecting lower for USO (Courtesy: ProfitSource by HUBB)

As you can see in Figure 1 the trade presently has an open profit of +$1,190.  So the goals (at least in this example) are:

*toextend the time left until expiration to potentially garner additional profits, while..

*Not allowing the sizable profit on the original trade to vanish.

So here is one possibility:

*Sell 30 August USO 15 puts at $0.35

*Buy 2 Apr 2016 USO 15 puts at $1.65

The results of this adjustment appear in Figures 4 and 5.  The “Days until Expiration” increases from 25 days to 263 days and Theta declines from a whopping -$35 a day to just -$0.73 a day.Figure 4 – Adjusted Trade  (Courtesy www.OptionsAnalysis.com)Figure 5 – Risk Curves for Adjusted trade  (Courtesy www.OptionsAnalysis.com)

As you can see in both Figures, we are risking roughly $300 of our open profit (i.e., we are playing with the “house money”) with the hope of making more money if USO does in fact fall to $12 or lower as projected by the Elliott Wave count.

Jay Kaeppel

Well here I go again breaking one of my own cardinal rules again – i.e., being critical of someone else’s writing.  Must be getting cranky in my old age.  Anyway, I recently read an article calling margin debt “an indicator that predicts nothing.”  No the writer is actually technically correct for the most part.  Still this sort of surprised me as I remember learning from Norman Fosback’s 1975 classic “Stock Market Logic” that margin debt was a very useful indicator.  As with a lot of things it depends on how you look at it.

The author in the unnamed article accurately notes the fact that many other analysts are warning that “record margin debt” is a red flag or warning sign.  He also rightly points out that margin debt has been making new highs for several years now with no adverse affect on the stock market.  And up to this point I agree.  In fact, he is correct that there is no bearish implication to high and/or rising margin debt. Well, at least up to a point.  However, as Fosback taught, it is not so much the “level” of margin debt that matters as it is the “trend.”

A Trading Method Using Margin Debt and Credit Balances in Margin Accounts

There are some technical (read “extremely boring”) explanations that have to be made regarding the data used in this test (DO NOT STOP READING!!!!) If necessary, just skip the boring nitty gritty for now and skip ahead.  You have my permission).

The data comes from this site: http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=table&key=3153&category=8

*I am using two sets of data:

1) Margin Debt

2) Credit balances in margin accounts

*There is no data listed for credit balances in margin accounts for the entire year of 1966.  December 1965 lists a value of $1,666 and January 1967 lists a value of $640. So for lack of a better method I simply took the difference and divided by 13 to get $78.92 and subtracted that value from the running total for each month in 1966 (i.e., December 1965 = $1,666, January 1966 = $1,587.08, February 1966 = $1508.16, etc.).

*I calculate a 12-month moving average for margin debt. If the current month’s reading is above the 12-month moving average the indicator is considered bullish and vice versa.Figure 1 – Monthly Margin Debt versus 12-month moving average

*I calculate a 12-month moving average for free credit balances in margin accounts.     If the current month’s reading is above the 12-month moving average the indicator is considered bullish and vice versa.Figure 2 – Monthly Free Credit Balances in Margin Accounts versus 12-month moving average

*The data for a given month is released sometime during the following month (I am not sure if it is uniform from month to month in terms of release date).  So to analyze actual market performance based on indicator readings I created (for lack of a more creative name – Jay’s Margin/Credit Balance Index – that gets updated at the end of the month:

*At the end of the month, if the margin debt value for the previous month (which was released some time during the current month) is above the 12-month average of monthly margin debt readings, the Model gets +1 point (for example if June data is released on July 15th and the latest reading is above the 12-month average then at the close on July 31st the Index gets +1 point added for the month of August).

*At the end of the month, if the free credit balances in margin account for the previous month (which was released some time during the current month) is above the 12-month average of monthly free credit balances in margin accounts, the Model gets +1 point (for example if June data is released on July 15th and the latest reading is above the 12-month average then at the close on July 31st the Index gets +1 point added for the month of August).

*So at the end of each month Jay’s Margin/Credit Balance Index will read 0, +1 or +2.Figure 3 – Jay’s Margin/Credit Balance Index (Dec 1959-July 2015)

As you can see, sometimes both measures are favorable (+2 readings), sometimes only one is favorable (+1 readings) and sometimes neither are favorable (0 readings).

Does any of this matter?  Consider the following:

Summary

So it is correct to say that “record margin debt” predicts nothing and that fretting and worrying about it is pointless.  However, this also sort of misses the main point – i.e., it is the “trend” that matters and not the “level”.  Rising margin debt almost invariably accompanies a bull market.  But as Yin follow Yang (at least according to people who say things like that), “all good things gotta come to an end.”  And so too will the favorable reading from Jay’s Margin/Credit Balance Index (FYI, margin debt is presently in an uptrend and credit balances are not so the Index stands at +1 and will remain so through at least the end of August).

In the meantime just remember that the difference between +2,756% (the gain for the Dow when Jay’s Margin/Credit Index > 0) and -9.2% (the loss for the Dow when Jay’s Margin/Credit Index = 0) is what we “quantitative types” refer to as “statistically significant.”

Bottom Line: Enjoy the ride….because it won’t last forever.

Jay Kaeppel

As I wrote about here and here natural gas has showed a historical tendency to decline in price between June Trading Day #11 and July Trading Day #14 (Yes, I concur that it sounds ridiculous on the face of it, but, hey, the numbers are what the numbers are).

For the record, between the close on 6/15/15 and 7/21/15:

*September natural gas futures declined from 2.942 to 2.894, or a gain of $480 per a 1-lot short position (see Figure 1).Figure 1 – September Natural Gas (Courtesy: ProfitSource by HUBB)

*The ETF ticker UNG declined from $14.03 a share to $13.87, or -1.14% (See Figure 2)Figure 2 – ETF ticker UNG (Courtesy: ProfitSource by HUBB)

Not exactly earth-shattering but a profit is a profit.  For the record, this is the 23^rd time in the past 26 years that natural gas has showed a loss during this period (88.5% of the time)

Also for the record in earlier articles I highlighted an example of an option trade to take advantage of this trend and also highlighted a profit-taking example.

See also Jay Kaeppel Named Portfolio Manager for New Investment Program 

Jay Kaeppel

I usually like to do my own research and report on that.  But I am not above ripping off, er, I mean “highlighting interesting work” from other analysts.

See also Jay Kaeppel Named Portfolio Manager for New Investment Program 

A case in point is the chart in Figure 1 below which was created by Kimble Charting Solutions.  The chart displays the price action for the Gold Bugs Index (ticker HUI) and highlights those (rare) trading days when HUI declined by -10% or more.

Figure 1 – Gold Bugs Index 1-day declines of -10% or more (Source: Kimble Charting Solutions)

There were four periods when this happened:

1999 – There was a brief spike a few months later, but overall the “buy signal” generated here was quite “early” as gold tock prices subsequently fell quite sharply into late 2000 before finally bottoming out.

2002 – The first -10% day was also a little early in terms of “picking a bottom” but clearly worked out fine for a long-term investor.  The second -10% reading occurred in July 2002, by my figuring about three days before “the bottom”.  Note however that it did take a matter of several years for prices to work significantly higher.  So remember this is more of a “perspective” indicator and not a “short-term” but signal.

2008: Buying in at the first, second or even third “circle” shown during 2008 would have been the equivalent of “catching a falling safe” as price continued to plummet to the eventual low. Nevertheless, from a long-term perspective even these “too early” signals were followed by significant percentage price gains over the next several years and the “circles” that occurred near the 2008 bottom were followed by multi-year gains of several hundred percent.

2015: As you can see in Figure 2, on 7/21/15 ticker HUI lost over -10% in single day.  Thus a new oversold “circle” is drawn at the far right hand side of Figure 1 above.Figure 2 – Ticker HUI declines -12% in one day (Source: ProfitSource by HUBB)

Summary

So is it time to buy gold stocks?  Well that is the question isn’t it?  If the history of this particular indicator is any guide:

A) There is a good chance that it is a little “early” to start piling heavily into gold stocks.

B) We are beginning to witness “capitulation” as investors dump gold stocks.

C) We should not be surprised to see gold stocks trading significantly higher over the next several years.

Investors willing to adopt a longer-term perspective (I think there a still a few of them who haven’t yet died of old age out there) might consider one of two strategies:

1) Begin accumulating shares of gold stocks (maybe using ETF ticker GDX or Fidelity FSAGX) with the understanding that things could get a whole lot worse before they get better.

2) Wait for gold stocks to bottom out and turn higher using some sort of trend-following method (a simple moving average?) to identify when the overall trend has finally reversed to the upside.  Then buy gold stocks with the anticipation that the follow through to the upside will be significant.

Of course, there is always Option 3), i.e., do nothing.  Which is clearly the “low risk, low reward” approach when it comes to gold stocks.

Jay Kaeppel

I love a good bull market as much as anyone.  And I don’t like to fight the trend.  So if the stock market – having bounced off of an oversold situation recently – wants to burst forth to new highs I for one will not be a naysayer.

Er, OK, let me amend that.  I might be a naysayer, but I won’t fight the trend.

OK, wait, let me amend that.  I might be a naysayer and I won’t fight the trend, but I might consider hedging my bets depending upon what happens next.

Stuff Naysayers Say

Following the selloff in late June, early July, the stock market – particularly the Nasdaq – has rallied sharply.  In fact the Nasdaq – powered by the “cool stocks” like Google, Apple and Netflix – has gone pretty much vertical during this recent advance.  But there are a few concerns, to wit:

*As you can see in Figure 1, the Nasdaq (represented by ETF ticker QQQ) is the only major index that has broken out (so far) to a new high.  This doesn’t mean that other won’t follow suit.  But until they do the whole thing feels a little “iffy”.

(click to enlarge)Figure 1 – Nasdaq at new highs; Others…not so much (at least not yet); Courtesy: www.ProfitSource.com)

*Another yellow flag occurs when an index goes up but the majority of stocks do not.  In Figure 2 you can see that on 7/20 the Nasdaq 100 registered its 8^th consecutive up day.  However, note the Advance/Decline and New High/New Low numbers for the overall Nasdaq on the same day – i.e., both are “underwater.”

Figure 2 – The index is “Up”, the majority of stock are not

Two important things to note  regarding this divergence between index price and market action:

*A one day reading like this is not “the end of the world” nor is it a clear sign of “The Top”.

*At the same time, it is not a positive sign.

What’s a Bull To Do?

If you are in the stock market you have several choices at this point, including:

1) Do nothing.

2) Do nothing but worry a lot.

3) Sell everything.

4) Keep a close eye on whether SPY, RUT and VTI follow the lead of QQQ…..or vice versa.

Sure, human nature being what it is, most people will gravitate to #’s 1 and 2, but I am going to go ahead and suggest #4.

Summary

I wrote recently about an impending confluence of potentially favorable seasonal trends.  On that basis – and since it is a pre-election year – I “want to believe” in the bull and to give the bullish trend the benefit of the doubt.  So hopefully, SPY, RUT and VTI breakout to the upside and away we go.

But if the don’t – and especially if QQQ drops back below the red line drawn on Figure 1 – at the very least a bit of hedging may well be in order.

Jay Kaeppel

For the record, I own shares of Fidelity Select Biotech sector fund (FBIOX) and have for some time.  And I am glad for that.  Because they’ve done great.  All the more reason that I hate to potentially rain on my own parade.  Still….

As a side note, I personally do not trade off of chart patterns (although I know many people who do so quite successfully) but I do look t charts on a regular basis.  Every once in awhile I scroll through a list of all kinds of tickers (stock indexes, sector funds, bond related ETF, commodity, foreign stocks etc.) just to “get a feel” for what the heck is going on out there.  This exercise does not (typically) lead to specific “action” (as that would essentially be more “reactionary” and I am more o a systematic trader and investor), but it does cause certain things to “pop out” at me.  Like today for instance.

Biotech Then…

OK, so what follows below eventually leads to my rhetorical question for the day.

If you were around the markets in 1998-2002 then you probably remember what happened to biotech stocks during this period.  If not – or if you have blotted it out, Figures 1 and 2 should refresh your memory.  Figure 1 shows the “blow off” in biotech stocks.Figure 1 – Biotech stocks explode 1998-2000

From its low in September 1998, FBIOX advanced 379% in the next 18 months.  By March 6^th, 2000 FBIOX was already up +74% for the year!  Of course, most investors are aware of what happened next. And it wasn’t pretty.  Over the next 28 months FBIOX lost a staggering -72%.Figure 2 – Biotech stocks implode 2000-2002

And so we all look back at biotech in 1998-2002 as a classic example of a blow off top.

…and Now

So now let’s fast forward to today and take a glance at Figure 3….and then consider the rhetorical question emblazoned in red on Figure 3.Figure 3 – FBIOX 2015

Just asking.

Summary

So am I suggesting that biotech is “blowing off” and that everyone should sell all biotech holdings and run like heck?  Not necessarily.  Remember this is just a rhetorical question based on a gut reaction to a picture.      And to be fair, you could probably have asked the same question a couple of months or even a couple of years ago. And biotech has simply continued to surge higher.

On a separate note, when I went outside yesterday to have the dog walk me, er, to walk the dog, there was a bunny rabbit sitting in the garden enjoying himself as he nibbled away.  When the rabbit saw me he became very alert.  He stopped chewing and focused all of his attention on me.  Note he didn’t run away immediately because there was no indication that I was a danger (except maybe to myself, but I digress).  But he was “poised for action” even as he stood there perfectly still.  The first hint of danger and no doubt he would have fled quickly.

When it comes to biotech, I sort of feel like that bunny.

Jay Kaeppel

I tried to be a “Fundamentals Guy” a long time ago, I swear I tried.  I read everything about everything regarding the financial markets.  Then I would try to figure out what it all meant for future prices.  And after I figured it out I would enter a position and tell the markets what they were supposed to do.

Let’s just say that “the markets” didn’t much care about what I had decided they should do.  Hence the reason my trading evolved into a technical and seasonal approach.

Nevertheless, I still try not to be completely ignorant (I mean sure you get used to it after awhile but, well, never mind) regarding the factors that can move a given market.  As I wrote about here, when it comes to analyzing the fundamentals of various commodity related markets I like to follow James Cordier and Michael Gross of www.OptionSellers.com.

Here is their latest research on crude oil.  I found it to be interesting and I think you may too.

To see another (impressive) example of their analysis click here

To buy their book or learn more about it click here

To get all the information visit: www.OptionSellers.com

OK, here’s the weird part.  For the record I am not endorsing their service as I have never used it (although, also for the record – I have read their book cover to cover more than once).  I am merely highlighting a source of consistently very useful, interesting and enlightening information that I have enjoyed reading for many years.

Jay Kaeppel

As I wrote about here, soybeans have a tendency to display price weakness between July Trading Day #9 and August Trading Day #6.  This year’s period began at the close of trading on Tuesday, July 14 and extends through the close on August 10^th.

See also An Update on Natural Gas Seasonally Unfavorable Period

As I wrote about in the linked article, beans have declined in price during this period in 30 of the past 37 years (81% of the time).  Does this mean that beans will decline this time around?  Absolutely not (in fact, on a purely anecdotal basis, my neighbor recently returned from Indiana and mentioned that he was surprised how little seemed to be growing in the fields along the expressway – typically driving through Illinois and parts of Indiana this time of year involves a mind-numbing and endless array of strongly growing crop fields – so, hey, you’ve been warned).

In the meantime, as you can see in Figure 1 – so far so good (bad? In this case bad being good) as November beans are down $0.14 (or $700 a contract) here on Day 1. Figure 1 – November Soybeans (down hard on Day 1 of seasonally unfavorable period) (Courtesy: www.BarCharts.com)

Time to take a profit?  You’ll have to decide that one on your own.

Jay Kaeppel

As I wrote about here and here, natural gas has showed a historical tendency to decline between June Trading Day #11 and July Trading Day #14 (6/15/15 through 7/21/15 this year).

As you can see in Figure 1, with one week left to go ETF ticker UNG and September Natural Gas futures are both slightly below their levels of 6/15, but has been advanced strongly in the last week, so things still hang very much in the balance.  The ETF ticker UNG and September Natural Gas futures both tried to break out to the upside on 7/14 but then reversed back to the downside.  As I write natural gas futures are once again trying to move to the upside however, in the early morning of 7/15.  So the bottom line is that the end result for this particular seasonal trend this time around remains hanging very much in the balance.Figure 1 – Ticker UNG during “Unfavorable” Period so far (Courtesy: AIQ TradingExpert)

Figure 2 – September Natural Gas futures during “Unfavorable” Period so far (Courtesy: ProfitSource by HUBB)

From a trading perspective (and for what it is worth):

*I wrote about a potential option trade using options on UNG here

*And as I wrote here I would have taken the money and run on that option trade a short while back.  Yes, I understand that as the purveyor of this particular seasonal trend I should stick around to the bitter end and not take early profits and run away.

Sorry, it’s just my nature.

Jay Kaeppel