In an earlier post I stated that “I am not an economist, so I’ll save you the mumbo jumbo“. Well, I am also not a technician, but I like looking at charts. One of the biggest knocks on those who rely on technical analysis as a major input for a trading/investing thesis is that people tend to see what they want to see in a chart. I am often guilty of that myself. But I only use charts as merely one input when evaluating a trade set up, and often what I see in the chart conforms to my fundamental view.
Let’s use the EEM (the iShares MSCI Emerging Markets etf) for example. The one year chart looks like a reverse head and shoulders, with a recent break above the neckline at $36, and little overhead resistance until $40:[caption id="attachment_65697" align="aligncenter" width="600"] EEM since Jan 1, 2015 from Bloomberg[/caption]
EEM is now $10, or about 36% above its 2016, and 7 year lows. Taking a 10 year view, it appears that $30 – $35 might have been a massive support range, with long term technical resistance in the mid $40s:[caption id="attachment_65698" align="aligncenter" width="600"] EEM since Jan 2006 from Bloomberg[/caption]
But here is where I get tripped up. Regular readers know I have a cautious stance towards global growth. I have not been swayed in any meaningful way by the resilience of risk assets. I see the low and negative yield environment posing more harm than good for reflation of global growth (but you have heard it before). When I look at this picture I see a breakout that got exhausted right where it should have ($38). I see the potential for one headline to send the EEM right back to the prior breakout level, and I’d rather trade that than a continuation of a rally that exists because investors have become accustomed to climbing walls of worry.[caption id="attachment_65700" align="aligncenter" width="600"] EEM ytd from Bloomberg[/caption]
So What’s the Trade?
*Buy the EEM (37.70) Sept 2nd/ November 36 put spread for .70
- Sell 1 Sept2nd 36 put at .15
- Buy 1 Nov 36 put for .85
Rationale – This trade works best if EEM’s rally fails over he next couple of weeks and the etf pulls back towards its recent breakout level. If that were to occur there’s plenty of things that can be done with the trade including taking profits or continuing to roll the short put.
There’s growing talk that September’s FOMC meeting could be live. We also are in the midst of the August doldrums in the markets as most of the globe’s traders are in and out of the office. That changes for the most part in a couple weeks. This calendar sells a put that expires the Friday of Labor Day weekend and becomes a November put afterwards, that both catches the Sept FOMC meeting and the possibility of a return of some volatility following the Summer. Right now the November 36 put has a theta of .01. Meaning it loses about 1c a day in value (assuming no changes to implied vol). The sale of the Sept2nd expiring 36 put makes up for that decay as it’s about .15, covering the time decay for the balance of August. (this is an oversimplification of how this works but it’s essentially right for trading purposes).