After a fierce equities rally on Friday, which I figured would happen, just not that strong; I have to wonder if there is some event or major decision in the works we don’t know about?
Friday’s rally could be something simpler like window dressing by the funds. This is when the funds buy up all the top performing stocks for month end reporting. They do this so that their investors think they are on the ball and know what they are doing. Window dressing will end Monday and from there we could see some profit taking (selling) start. But for all we know Obama could be extending the tax cuts for everyone or cutting payroll taxes etc…
It would only take one of these events to trigger a sharp up move in the market and that could be what Friday’s move was anticipating. That being said volume has remained light and during low volume session the market has a tendency to move higher. Sell offs in the market require strong volume to pull the market down, so until volume picks up there could still be higher prices just around the corner.
Let’s take a look at some charts…
SPY – SP500 60 Minute Intraday Chart
Last week we saw the market reverse to the down side with a strong end of say sell off. That set the tone for some follow through selling and for any bounces to be sold into. That being said, the market always has a way of surprising traders and it did just that on Friday gapping above Thursday’s reversal high causing shorts to cover and the typical end of week light volume drift to help hold prices up.
NYSE Market Internals – 15 Minute Chart
I like to follow some market internals to help understand if investors are becoming fearful or greedy. It also helps me gauge if the market is over bought or oversold on any given day.
These three charts below show some interesting data.
Top Chart – This indicator shows me if the majority of shares traded are bought or sold. When the red line spikes up and trades above 5 then I know the majority of traders are buying over covering their shorts. I call this panic buying because traders are buying in fear that the market will continue higher and they will miss the train. When everyone is buying you know a pullback is most likely to occur.
Middle Chart – This is the NYSE advance/decline line. When this indicator is below -1500 then the market is over sold and bottom pickers/value buyers will step in and nibble at stocks. But when this indicator is trading over 1500 then you know the market is overbought and there should be some profit taking starting any time soon.
Bottom Chart – This is the put/call ratio and this tells us how many people are buying calls vs put options. When this indicator is below 0.80 level more traders are bullish and buying leverage. My theory is if they are buying leverage for higher prices, then they have already bought all their stocks and now want to add some leverage for more profits. When I see the majority of traders bullish then I an sure to tighten my stops (if long) as top my be forming.
Putting the charts together – When each of these charts are trading in the red zone know I must be cautious for any long positions because the market just may be starting to top. Or a short term correction may occur.
UUP – US Dollar Daily Chart
The US dollar has been under some serious pressure with all the talk about quantitative easing (printing money). Obviously the more the Fed’s print the less value the dollar will have. The chart below shows a green gap window which I think once it is filled should put the dollar in a oversold condition for a short term swing trade bounce before heading back down. A bounce in the dollar will put pressure on equities, gold and oil.
GLD – Gold Daily Chart
Gold continues to grind its way up. This move is looking very long in the teeth and pullback will most likely be sharp.
Weekend Trading Conclusion:
In short, equities and gold continue to grind their way higher while the US dollar continues its grind lower. When I say the market is grinding I am implying the market is over extended and a reversal any day should occur.
Financial stocks like Goldman (GS) which typically leads the market has been strongly underperforming over the past week. Insiders were selling GS very strongly which is strange and makes me wonder what’s up there? With the financial stocks underperforming it sure looks like a market reversal is just around the corner.
If Friday’s rally was simply window dressing by the funds then it should end on Monday and with any luck we will see a sharp reversal to the down side early this week.
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Let the volatility and volume return!
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In recent articles, we discussed that Theta (Time Decay) has the potential to cause option prices to decline dramatically, particularly in the final weeks leading up to option expiration. As it turns out, we are now
I wanted to take this opportunity to illustrate some potential strategies to trade GLD. While futures and equity traders are forced to wait for a breakout or a selloff, option traders have the unique ability to profit from the passage of time. The chart below is the GLD weekly chart.
I rarely use weekly charts, but I have had a lot of success in the past using the weekly chart when trading options on the gold and oil ETF’s. Gold is coming into a wedge and I am sure that opinions range far and wide which direction price is headed. As an option trader, it really does not matter too much to me which direction price goes as long as price will stay within a predictable range. Below is the daily chart of the gold ETF, GLD.
Quite frankly I could care less what gold does over the next year, my focus is on what gold will do in the next six days. One of the unique characteristics of options is the ability to truncate the market exposure to a sharply defined time window.
I do not have a directional bias, but I am expecting GLD to consolidate for the next several days before making a break in either direction (the first move is often times the false move.) A basic strategy would be to utilize a call/put credit spread. Based on the chart above, the 124 price level represents some relatively significant overhead resistance. At the same time, the 50 period simple moving average represents a key support level. The chart below illustrates the risk/reward of a call credit spread. The terminology can be confusing since the same trade can often be designated by the same name; in this case, this could also be termed “selling a call vertical” or a “bear call spread.”
The trade setup involves selling 4 Sept. 122 GLD Calls and simultaneously purchasing 4 Sept. 124 GLD Calls. To make the calculation simple, I am using the Thursday closing prices to illustrate this trade. Obviously the trade would change based on market conditions tomorrow. The maximum risk on this trade is $592 not including commissions. The maximum gain at expiration is around $208 not including commissions. A similar trade could be used for traders expecting gold to rally. The trade would utilize puts instead of calls and would be setup selling the SEPT 121 Puts and buying the SEPT 119 puts.
For our short biased trader, if GLD were to close below $122/share or lower at option expiration, the trader would make the maximum gain of $208 which represents over a 30% gain based on risk. Keep in mind, this trade has a maximum gain of $208, thus if price were to collapse totally the trader would only earn $208. On the flip side, if GLD were to close at $124/share or higher, the trader would lose the entire $592 that they risked. The trader with a long bias would collect the maximum profit if GLD’s price at option expiration closed above $121/share and he/she would sustain the maximum loss if GLD’s price at option expiration was below $119/share.
A successful option trader I know personally refers to this time of the option cycle as “Butterfly Season.” For those of you new to options, butterflies are the nickname of a multi-legged option strategy that traditionally uses Theta Decay (time decay) as its primary profit engine. A butterfly gets its name from the way it is constructed. A traditional butterfly involves purchasing two option contracts at different strike prices with the same option expiration while selling like contracts evenly spaced between the contracts purchased in a combination of 1 /-2/ 1.
Since we are nearing option expiration, butterflies become a very popular choice for experienced option traders because they offer limited risk and give option traders the opportunity to potentially profit from the inevitable time decay that is right around the corner. Theta decay is as inevitable as the passage of the tides; the time value of options goes to 0 at expirations. This decay is not negotiable and occurs each and every options cycle. As you will see shortly, the close proximity to option expiration presents incredible risk/reward setups when butterflies are utilized appropriately. Just as a basic reminder, I am using Thursday’s closing prices to illustrate this trade and obviously market conditions will change during trade tomorrow.
I selected the following setup to construct a butterfly that will profit if price continues to decline or consolidates over the next few days. The setup consists of September GLD puts in the following setup: Long 1 SEPT GLD 116 Put / Short (Sell) 2 SEPT GLD 119 Puts / Long 1 SEPT 122 Put. The trade is placed simultaneously and a trader’s account would be debited a total of $86 dollars to place this trade. For educational purposes, if a trader wanted to take on more risk he/she could increase the size of the butterfly, however to maintain a standard butterfly they must be increased in the ratio
Keep in mind that an option butterfly could be constructed using calls with the exact same strikes in the same setup for a similar profit. However, it usually behooves an option trader to chart both contract types to see which contract offers the most profit. Implied volatility can have slight differences based on the broad markets expected price direction of the underlying. For option traders using relatively small butterfly orders this is not a huge difference, for option traders that swing big and wide the slight difference can really add up, particularly for those trading more than 100 contracts per side.
The maximum loss the put butterfly can sustain is $86 per side. So, my original trade of 1/-2 /1 has a maximum loss of $86. The trade will be profitable at option expiration if GLD’s price closes between $116.90/share and $121.10/share. The maximum gain this trade could earn would be an expiration that closed exactly at $119/share. The maximum gain on this trade is around $218. While it is unlikely that GLD will close at exactly $119/share, if it closed near that price level, the trader would realize well over a 100% return based on the capital they risked. The chart below illustrates the profitability of our GLD butterfly position.
The red lines represent profit or loss at option expiration, the white line represents profit based on GLD’s price as of tomorrow based on the closing option prices and implied volatility. Clearly these numbers will change tomorrow when the market opens and throughout the trading day.
It is critical to keep in mind that the trade could be exited for gains before option expiration. Contingent stop orders could be placed to prevent maximum losses from occurring, and the initial range where profitability resides will be wider than $116.90 – $121.10, however every day that passes the gap will close until option expiration. There is an additional risk to this strategy besides just GLD’s price action and that is implied volatility. If GLD’s implied volatility increased dramatically causing the underlying option premiums to extend higher in price, this has the potential to dampen returns. However, as long as price cooperates and stays within the profitability bands, at option expiration the trade will be profitable since volatility impacts only the time value portion of the premium and we know that goes to 0 at expiration.
Butterflies are scary for beginners, but once a trader understands how they work and additional ways to manipulate them to enhance or protect profits, they become an absolute favorite trading strategy for many. Also notice that by using the butterfly strategy a trader can reduce his/her
If I were going to use options to capture potential profit in the price action of gold, it is without question I would utilize a butterfly at this point in the option expiration cycle. The best part about using a butterfly is that its primary profit engine (Theta Decay) is inevitable. However, option traders that utilize this strategy must monitor implied volatility closely and as always, price action certainly matters regardless of which direction GLD decides to go. In addition, as butterflies approach their inevitable denouement at expiration, they become increasingly sensitive to price as the theta decay finishes its work. For this reason, price must be monitored carefully and dramatic price movements at expiration must be dealt with decisively.
In closing, I will leave you with the insightful muse of Rabindranath Tagore, “The butterfly counts not months but moments, and has time enough.”
in that very period of time and option strategies that utilize Theta (time) decay as their profit engine can really produce some outstanding risk/reward opportunities. Vertical spreads, butterflies, and iron condors can all be utilized to create profits in this environment, with a crisply defined amount of risk. When risk can be accurately defined, option traders can shape their expected perception of price action around their own unique time frame and risk profile. In cases where these wedges present themselves, it usually takes several days before the underlying will tip its hand as to which way price will go. As stated above, we know that options will expire in six trading sessions and we also realize that the chart pattern lends itself for gold to stay within the wedge at least for the next few days. When I look at a chart like this at this point in the option expiration cycle, I am thinking about one thing – THETA DECAY! How can I build a trade that will utilize Theta Decay, and give me a significant opportunity to realize a solid profit while taking a finite amount of risk? of 1 /-2 / 1. So if a trader wanted to risk a total of $860 (10x bigger), they would put the trade on in the ratio 10/-20/10. risk and achieve similar returns to the call/put credit spread illustrated above. If you would like to receive our free educational options articles and trading signals please join our free newsletter at:
Precious metals soar as investors flock to gold and silver. But are they looking deep enough to truly understand the current trends at hand?
When reviewing the metals sector I like to look at it from different angles to get a solid understanding of the patterns and trend forming. I follow multiple time frames along with monitoring the gold mining stocks. Gold stocks tend to lead the price of gold bullion and when its out performing the price of gold substantially by 10% or more you should be expecting a pause or pullback in both gold stocks and gold bullion prices temporarily.
Below are a few charts showing the long and short term trends for gold.
Gold Bullion Price – Weekly Trend Chart
Gold continues to be in a strong up trend. The occasional test of support at the major moving averages can provide great long term points for adding to a position. The 50 period average is one which is tested frequently.
Looking at the weekly chart does give me a red flag for the intermediate price of gold. While the trend is clearly up I can’t help but notice the rising wedge which is a bearish pattern. During an uptrend we want to see bull flags and pennants, not a grind higher forming a narrowing range. This grind higher could unfold much similar to the price action of 2005 and 2007 instead of a correction but I am leaning more towards a sharp correction because more people are bullish on gold now then they were during the June top.
For those looking at gold as a long term investment/currency can be patient and wait for a pullback to a major moving average before adding to your position then you would lower your overall risk for this position. You will understand after reviewing the following charts.
GLD – Gold Bullion ETF – Daily Chart
(This fund moves identical to spot gold price so even though I am showing you GLD fund, the spot gold chart is doing the exact same thing.) As you can see below the price of gold is trading at resistance and becoming choppy. Buying gold at resistance does not make much sense to me. There is a very good chance gold will move lower in the coming weeks providing a better price for long term investors to add to their positions. For example, if you waited for the weekly chart to pullback to the 50 period moving average that would be like buying this GLD fund at $113, which is an 8% discount.
Gold continues to hold up within its channel but this week we could see fireworks if the price breaks below the blue support channels.
Gold:Gold Stocks Comparison – Daily Chart
This chart shows the performance of gold vs gold stocks from the Feb 2010 lows. The blue line is the performance of gold stocks while the red line shows gold’s performance. It’s obvious that when everyone is bullish on gold they buy the highly leverages gold investments in order to take full advantage of the upcoming move. This is much like reading the put/call ratio for trading the SP500 and it measures the bullishness of the precious metals sector.
When gold equities are strongly out performing gold bullion you should be thinking about raising your stops, taking partial profits and or hedging your long term position until the sector stabilizes is not trading at a premium.
Precious Metals Sector Trading Conclusion:
In short, Gold is in a strong up trend and will remain in one for a long time. Commodities have higher percentage of going parabolic. That means there’s a small chance that gold continues to move up quicker and quicker surging hundreds of dollars in a very short period of time. That being said, it’s not very likely, and from a technical point of view those buying gold now are paying a premium in my opinion.
Being a patient trader is not easy, but waiting for low risk entry points is very rewarding on many different levels when done correctly.
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Bulls are about to move the markets higher
By: David A. Banister
I’ve been busy counting the months of correction since Mid-April this year when I forecasted a top in the U.S. Markets following a massive 13 month rally off the March 2009 lows. The theory I had at the time was that the % of bulls in sentiment surveys was running at nearly 3 to 1 over Bears. 57% of those surveyed were Bullish in Mid-April and only 20% were Bearish. In addition, we had completed a clear 5 wave bullish pattern up from the March 2009 lows, and the time period of the rally was also a Fibonacci ratio.
Since that time, we have dropped to as low as 1011 on the SP 500, which is a 38% Fibonacci intersection of the 2007 highs to 2009 lows, and also the 2009 lows to 2010 highs. This created a platform for a calendar year bottom, and since then we have marked some time rallying up to Fibonacci pivots and back down again.
The most recent action is what really caught my eye and my subscribers were made aware a few weeks ago to prepare for a rally. The drop from 1130 to 1040 on the SP 500 was a “corrective pattern”, meaning it was in a three wave formation. 60 points down to 1070, 30 points up to 1100, and another 60 points down to 1040. This also lined up with the May 25th bottom and is yet another Fibonacci intersection. The rally up last week was extremely strong off the lows, and admittedly probably caught some bears off guard and caused short covering as well. What really woke me up as I did my research over the weekend was the sentiment surveys through last Tuesday.
The percentage of Bulls in the survey had dropped to 29% whilst the Bears had roared ahead to just over 37%. This is the first time that the Bears had been this high in the surveys in a very long time, and in addition, the last time the Bulls percentile readings were nearly this low was back in March of 2009, at 26%. Typically these types of readings when coupled with what I believe to be bottoming or “corrective” wave patterns often lead to big rallies and catch people off guard. Conversely, overly bullish readings as in Mid April concomittant with certain Elliott Wave patterns I identify often lead to tops as well.
What I expect now is a pullback to 1080, possibly 1070-1074 on the SP 500, and then a large rally to roughly 1145. This will encounter some resistance there as it also is a 61.8% Fibonacci pivot of the 2010 highs and the 2010 lows. The pendulum appears to be swinging back to the Bulls, and I expect that following the first full week of October we will be rallying up past 1160 on the SP 500 and then challenging the 1220 highs of April of this year.
A side note on Gold and Silver as well: I wrote a forecast on silver last week with silver at $18.73 an ounce predicting an imminent move above $19.50 with a breakout leading to $26-$29 per ounce over several months. At this time I favor Silver over Gold performance wise for the foreseeable future, and I still like Gold moving to the $1300-$1325 per ounce level in the coming months.
Below is my projected SP 500 chart recently released to our paying subscribers at TMTF.
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The Silver Summit Sets 2010 Conference Dates
October 21-22, 2010
The Silver Summit, Inc. is pleased to announce it has finalized dates for its eighth annual Silver Summit to be held Oct. 21 and 22 at the Davenport Hotel in Spokane, Washington.
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Kitco Metals eConference
September 12-13, 2010
Kitco Metals eConference, an online, two-day event showcasing all aspects of the metals industry, with a primary focus on precious metals.
Investment and networking opportunities in metals exploration, mining, manufacturing, processing and end-use applications will be presented and discussed live and in real time on September 12 and 13, 2010.
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Silver is one asset class I do not cover very often, but have been largely bullish on since $6 an ounce many years ago. It can be considered “poor man’s Gold” as they say. I believe Silver is about to stage a pretty large advance based loosely on the Elliott Wave pattern I see unfolding after a 9 odd month consolidation. (Obviously, there are also fundamental fiat currency/debt events worldwide that give it the underlying bull chart pattern). Since the average person can’t run out and buy an ounce of Gold for $1,240 tomorrow, as the unfolding of the fiat crises continues to enter the public psyche, you will see a strong populace movement into buying silver, silver coins, etc. To wit, many silver stocks are moving up strongly of late, signally an imminent breakout of this precious and industrial metal.
The triangle pattern has taken nearly 9 months so far, and a move over $19.50 could start a multi-month run targeting $26-$29 per ounce for starters before a broad pullback. A few silver stocks worth looking at include SLW (Silver Wheaton, which purchases future silver mine production in advance at a discount), a long-time favorite of mine and Fortuna Silver, a growing producer and explorer favored by some of the brightest minds in the business. I do not own shares in either, so I have no inherent bias to mention them other than they are worth your time to review sooner than later. TMTF does not offer stock or trading advice, so please do your own research and consult a professional if need be.
I post the Silver chart below and my outline shows my views of a multi month 5 wave bullish triangle pattern on a weekly chart. Silver needs to bust through $19.50 per ounce to confirm, but I suspect we will see this fairly soon.
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David A. Banister
Chief Investment Strategist and Founder