February 11th, 2018

Option Queen Letter
By the Option Royals
Jeanette Young, CFP®, CFTe, CMT, M.S. and Jordan Young, CMT
February 11, 2018

In today’s market, there are more ETFs than there are listed securities traded on exchanges. When the markets decline some of these ETFs are sold which means that the ETF fund must rebalance their holdings to reflect that change in the ETF. Say the ETF holds IBM, AT&T, AMGN, AAPL, INTC, ETC. If that ETF is sold, the appropriate number of shares of all the above listed stock must be sold to reflect an accurate count. So, what you see is a double sale, first the ETF, and then the stocks that make up the ETF that was sold, a double whammy with regard to the downdraft.. In contrast, when shares of a mutual fund are sold, either a fund portfolio managers chooses what to sell, or the decision is made automatically by the fund’s investment statement. Understanding these dynamics and margin, shows how the ETF proliferation may have led to greater downside volatility.

After the market has an aggressive decline, margin calls are issued which must be answered with cash, be it from the sale of issues in the account or through the injection of additional cash. When stocks are sold to answer a margin call, more margined shares than would seem logical must be sold to cover the call. Why? Because these issues are margined or hocked and have a specific liquidation value which may, in some instances be less than 50% of their value and indeed can drop to 30% of the value or even a New York Stock Exchange call at 25%, which would cause a serious call.. What does that mean? Well, if you owe 1000 dollars and the margin clerk sells you out of 1000 dollars in stock that is 60% margined, you only have 400 dollars of value in that stock. You will have to sell more stock or bring in funds to answer the call. Many investors, play the waiting game and wait for the market to rally hoping that the call will be answered by the appreciation of stocks and bonds in their respective portfolios. Unfortunately, many times this does not happen and, if the call is not met by a set date and time,, the margin clerk pick stocks to sell out, generally the most expensive and liquid. They don’t care which stocks they are they only care about meeting the call. Of course, as all of this kicks into gear, the trend following funds and algos jump on the short side, riding the wave while simultaneously stirring up the ocean.

The S&P 500 added 28 handles (points) in the Friday session. The weekly action saw the index drop to just a point above the week’s low. We have divergences showing up on the chart. Although the downdraft was steep, neither the RSI nor the stochastic indicator made a lower low, instead making a higher low. This is a positive sign signaling that the index may have put in a bottom this past week. The most frequently traded prices were 2603.25 and 2596.75. The most volume was seen at 2587 where 6.7% of the Friday’s volume traded. The point and figure chart looks like a ski slope with some stability at the bottom. The S&P declined to levels not seen since October 2017. Please remember that the rally since then has been extremely aggressive and that this sell-off was to be expected. Heated up markets, like stove top boilers, must let off steam lest they explode… All of the indicators that we follow herein are issuing a buy-signal. The Bollinger Bands are expanding which tells us that volatility is not going away any time soon.

The NASDAQ 100 gained 108.50 handles (points) in the Friday trading session on good volume. This index did print a low for the 2018 trading year. The print removed the previous low seen on February 6th. This is not a “good thing.” It indicates to us that the low could be tested again. On the other hand, that low had divergences in the indicators that we follow which all printed higher lows, even with the lower low seen. That is a positive, but, we need to see some follow through. The Bollinger Bands are expanding which tells us that volatility is going to continue. All the indicators that we follow herein are issuing a buy-signal. Remember, as we rally back, sellers are going to appear. The “get even” crowd will pop up at every move to the upside. Their entire purpose is to get out at the price that they purchased. Like touching a hot stove, once burned, it is unlikely that you will place your hand on the burner again until some time has passed, and even then, you likely will never forget the pain and anguish of the injury. The most frequently traded prices were 6342.70-6351.80. The heaviest volume was seen at 6342.70 where 7.6% of the day’s volume traded. The point and figure chart clearly shows the fresh low this past week. There is nothing on this chart that is positive except that the RSI is oversold but not bending to the upside, which tells us to be careful.

The US Dollar Index rallied 109 handles (points) in the Friday session leaving an inside day candlestick on the chart. The Bollinger Bands are contracting but look as though they are leveling out. All the indicators that we follow herein continue to issue a buy-signal. That said, our own indicator is curling to the downside and likely will issue a sell-signal in a few days. Notice that the US Dollar Index rallied in the face of the major sell-off in the financials. This visually shows that the US Dollar was used as a safe haven and a place to park money in a global stock market retreat. Commodities are also less correlated to the price of stocks and do help stabilize the portfolio values. The US Dollar Index closed above the downtrend line giving some hope to the US Dollar bulls and some fear to the bears. Nice “V” bottom on this but will it hold? We need more than a single day’s close above the downtrend line to feel better about this index. The weekly chart does not show the positive close above the line, thus, we have to wait for confirmation. The monthly chart continues to look negative with a double bottom at 88.255. The most frequently traded price was in the overnight session, 90.125. As you know a strong US Dollar impacts the price of commodities traded in US Dollars. Thus, we have seen pressure on crude oil, gold, natural gas, etc.

Crude oil lost 2.10 in the Friday trading session. The stochastic indicator is issuing a buy-signal but both the RSI and our own indicator continue to point lower, although both are at oversold levels. The Bollinger Bands continue to expand projecting increasing volatility. Good support for crude oil is seen at its current level and at 55.79. Resistance will be seen at 62.85 and at 66.66. The most frequently traded price was 60.45, most of the volume for which was seen in the overnight session. The intraday chart shows that most of the day-session was spent on the downside with adjustments at the close gaining back some of the losses. Both the weekly and monthly charts do not look very inviting.

Gold retreated 2.4 handles in the Friday session. The Bollinger Bands are flattish indicating that there is no increase or decrease in volatility. Both the stochastic indicator and the RSI are issuing a fresh sell-signal. Our own indicator is issuing a buy-signal. Perhaps some of the weakness in gold was caused by the rally in the US Dollar. It is acting more like a commodity, at the moment, than a currency. Gold needs to hold above 1307 or it risks a retreat to 1290.10. Below that number there is an island and then support at 1276.30

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