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business newsThe Wednesday Structured Trade: Ride the SPX Wave, Behold the W.W. Grainger DeMark Trifecta
By
Fil Zucchi
Dec 07, 2011 9:40 am
SPX short dated calls may work if we run up into year-end, while GWW looks "exhausted" on multiple time frames.
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The recent failure of a German bond auction appears to have triggered a newfound religion on the part of Germany and France in the form of focusing on how to reduce the amount of debt smothering the European Union. Over the weekend Italy announced €30 billion worth of spending cuts, and the December 9 EU summit is expected to produce proposed changes to the European Union treaty to force all countries to tighten their belt.
Operating on the belief that these measures will solve the European problems, world markets have screamed higher. The austerity measures of course will not benefit the European economies or their markets, but they could give cover for Germany to wink and nod at the European central bank to "do more" to ease the current bond crisis. Of course, "doing more" simply means monetizing the debt, a.k.a. printing money, and, right or wrong as it may be, printing money is something financial markets always appreciate.
I am not at all convinced that when the euphoria fades Europe will be a new beacon of fiscal restraint, nor that Germany will abandon its anti-monetization principles and allow weaker countries to retire the debt with freshly printed paper. But that is neither here nor there; for now euphoria and end-of-year performance chasing is on, and it will be a tall order for the bears to fight the momentum.
It is within this framework that I get to choose this week's structured trades. On the long side I have chosen not to get cute and to ride the S&P 500 (SPX). If broad momentum is the name of the game and what traders are focusing on, it seems silly to go fishing for individual names when closing your eyes and riding the market can get you to the same place without running the risk of a stock-specific blowup. Nor do I really care about fundamentals at this point because as you will see from the discussion of the technicals, this trade has a rather short lifespan.
On a traditional chart the SPX is bouncing against a downward sloping 200 DMA at 1,264. But on a daily DeMark chart we are only on bar five of a TD Sell Setup, and there is room to clear the 1,277 level before we will complete a TD Countdown Sell. In addition, resistance doesn't show up until 1,331 (TDST Level Up) and the 1,346 area which represents the target of a couple of qualified TD trendlines.
The play I am thinking of involves a 1 x 2 call spread going long the December 30 1,270’s and going short the December 30 1,330s. At this writing the ratio can be bought for about $14.60 which puts our expiration breakeven price at 1,284.60 on the low end, and 1,375.40 on the high end. A very big word of caution: Being net short S&P calls is not for the faint of heart. Going into the position, this ratio spread has a net delta of .15. Should the market run-up happen in the next couple of days, and were it to cause the delta to flip negative, prudence may argue for closing out the position at a small loss rather than ruining your holidays wondering whether this trade will put an ugly dent in your P&L. (To lower the risk profile and reduce the margin implications of this spread, consider using the S&P 500 spiders (SPY) instead).
On the short side of things I am really intrigued by WW Grainger (GWW). There is nothing really wrong with the fundamentals, except that the stock might be a little bit pricey on a P/E basis relative to its 10-year average multiple. But the DeMark technicals show a very rare convergence of completed TD Sell Countdowns on daily, weekly, and monthly timeframes. All the counts were just recently registered, and on the daily and weekly charts they pretty much coincided with the completion of TD Wave 5 moves. And if that were not enough, a Tuesday close below $186.90 would provide us with a price flip on the daily chart.
The option implied volatilities are also conveniently low, showing a discount to realized volatilities across the entire option chain; the April series is as much as 10 points below realized volatility. So here is how I would play: I would buy a 1/3 position in the April 185 and 135 puts, and look to add to these positions as the stock moves higher, but keeping a mental stop between $198 and $202. If/when the stock does turn lower, I would sell in scale the 160 puts until I am left with a "butterfly spread" at little if any cost. The risk here is that the stock goes higher without interruption and our long puts decay before we have a chance to sell the 160s.
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Position in SPX
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