When The Leaders Start To Lag (DIA, IYT, and LQD – Oh my!)
We’ll start, as usual, with a look at a couple of trades that require attention.
Let’s look at a trade we initiated back in July of last year, a PUT position on the iShares iBoxx Investment Grade Corporate Bond ETF (NYSE:LQD).
In short, the trade didn’t work out.
Have a look at the chart:
This one is particularly painful, because we were on the right side of the trade twice, and ended up losing because we didn’t play our cards smart.
To wit – we bought our PUTS when the stock’s Relative Strength Index (RSI) registered an extreme overbought reading on July 23rd of last year (black ovals). The stock subsequently fell sharply and we were nicely in the money, but lost out because we decided to hold out for further gains.
Now, we’re normally quite happy to scalp a chunk of cash out of our trades rather quickly. Here we didn’t. Call it greed or overconfidence or whatever, but we made the mistake of holding because we leaned too heavily on the 80+ RSI print. The stock subsequently bottomed and bounced higher (red circle), eroding all of our gains and pushing us closer to the December expiry.
Then, on the 29th of October in Fixing a Liquid Spill, with our deadline fast approaching and sensing we were at new highs for the move, we rolled out our PUTS to the March expiry (blue oval), and again our timing was impeccable. A new top had formed, and the move lower was commencing. Our mistake came in giving the trade just five months to work. LQD backed off consistently since we re-geared the action, but not fast enough to put us in the black – nor even to offer enough premium to roll the trade out a second time.
We ended up with nothing.
Total loss on the trade was the full premium: $2.20 per option.
Pay Close Attention! – DIA
The second trade we want to address was initiated on February 18th in Playing a Near Term Pullback. In that issue we recommended a calendar spread on the Dow, selling the near term (March) DIA 140 CALLS and buying the June 140’s. The trade cost us $1.78 to initiate.
With the expiry of the March options our accounts are now short 100 shares of DIA and long the June DIA CALLS.
For those still on board, as of Friday’s close you are in a loss position of precisely $490 on the short sale. Against this, you are in a profit position of $660 on the long June CALLS. If you close the trade today you will be up $170 (660-490). Taking into account the cost of the trade, $178, your total P/L for the effort is an $8 loss.
But you have at least two other options.
For those who are near term bullish, we suggest you cover the short and ride the long CALL higher.
For those who are near term bearish (and possess enough margin to keep the trade open), we suggest selling the CALL and riding the shares lower. It is imperative that anyone choosing this latter option place an immediate stop buy order on the shares at $145.50 – a level just marginally higher than the all-time high set two weeks ago. Should that level be bested we’ll likely see further gains, and you won’t want to remain on the short side in that case.
Of the three options listed above, we believe readers should consider their own risk profiles and act accordingly, specifically -
- If you’re a more conservative type, we strongly recommend you get out now with your $8 loss and call it a day.
- If you’re happy to take on a little danger, and even sustain a little loss, choose the bearish option listed above, sell your CALL, sit on the short, and set a stop buy order immediately as indicated above.
- If you want to throw caution to the windy city and open yourself to a potentially heady gain, close out your short and let the CALL ride. Considering the now strong possibility of a near term pullback for the indexes, be wary also that your current profit position could be substantially eroded by the time the June expiry strikes.
For our part, we’re closing the trade today, and taking our burger and fry loss. Those of you who remain are on your own.
What can we say? Nobody shoots 100% from the free throw line…
A New Week – A New Trade
We believe there’s a great deal to be learned from those sectors that are market leaders, stock groups that pull the indexes to new highs and attract broad media attention along the way. What’s particularly telling is when these same sectors give up their leadership role and turn lower.
A few sectors now that fit that bill. Certainly the financials have been leaders of late, consumer discretionaries and health care, too. But none has really captivated us like the transportation stocks. This group has advanced tremendously since last bottoming in mid-November, up 30% since then, hitting new all-time highs as recently as last Tuesday before turning over toward week’s end.
Here’s a chart that graphically documents the sector’s outperformance. It’s the transports, represented by their proxy IYT, against the Dow for the last six months.
Where the Dow (represented here by the SPDR Dow Jones Industrial Average ETF (NYSE:DIA)) gained 7%, the transports were up by almost 25%.
We’ve documented the trannies overbought status in this space of late, and we do so again now to reiterate just how serious the predicament may be.
With both RSI and MACD diverging lower against price and the recent 80+ overbought reading of late January, we believe IYT’s momentum is now breaking.
A look at the last full week’s action may also point to a break in the transports’ recent run.
Where the trannies had led the Dow for the last four months, here we see them lagging.
To us it looks like the cloth is torn.
And we expect the rip to get bigger.
We’re therefore writing a zero premium trade pitting the Dow against the transports.
Wall Street Elite advises readers to take appropriate action on the DIA spread discussed above
to purchase the IYT September 105 PUTS for $$3.90 and sell the DIA September 138 PUTS for the same price in equal numbers.
With kind regards,
Hugh L. O’Haynew, Senior Analyst, Oakshire Financial