Oil Services about to Spill (OSX,DIA,IBB,IYZ)

We want to take a brief look at the major market indices before getting into our trade for the week, and in particular to understand the action of the last two months, since the Brexit micro-breakdown of June 23rd.

 

On the charts below are three months’ worth of daily trade from the Dow, S&P 500 and NASDAQ Composite.

1

As the charts demonstrate, the rally off the late June lows was formidable, bringing the indexes to new highs.  But it now appears to have stalled.  Trough to peak, the Dow notched a 9% gain, the S&P 500 10%, and the NASDAQ a wild 15% over the period, in a move that ran like a tireless (and shoeless!) Abebe Bikila in the 1960 Olympic games.

 

At this point, there’s resistance.  For the Dow and S&P, selling pressure arrived in mid-July, for the NASDAQ, over the last couple of weeks.  Resistance lines (in red) are indicated on all three charts.  Immediate support lines (also in red) have also been drawn below the recent price action.

 

At present, we’re in a sideways slide the ultimate outcome of which is anyone’s guess.

 

For the bulls, of course, it’s the pause that refreshes.

 

For the bears, it’s the end.  Sell everything.  We’re on our way down.

 

So where’s the truth?

 

More than likely, it’s somewhere in between.

 

That is to say, an all-out crash in the markets before a federal election is not a possibility, as it would all but seal the deal in favor of the Republican challenger.

 

On the other hand, the indexes have likely moved too far, too fast to muster any more upside for now.  And until they retreat and make contact with at least one of the mid- to long-term moving averages, it’s unlikely we’ll see any new move toward higher ground.

 

That means we could experience a meaningful retreat, something on the order of 1000 points on the Dow.

 

The other possibility is that we keep coiling eastward until all the excesses are burned off, and the moving averages have had a chance to catch up to price.  Should that occur, our vote will go on the long side.  As close as we may be to the bull market’s end, we just don’t think she’s done.

2

As the chart above shows, this is the second longest range-bound period since the bull market began back in March of 2009.

 

And when it breaks, the move will almost assuredly be fast and lengthy.

 

And we’re going to try to anticipate it.

3

Before we get to today’s initiative, we have one trade to close today, a recent one, from A Higher Market… in Spurts, that arrived in your inbox on the 18th of August.

 

There, you’ll recall that we urged you to buy the IYZ February 31 CALL for $2.20 and sell the IBB January 355 CALL for $2.45.  Total credit on the trade was $0.25.

 

Our thinking was straightforward.  As we wrote then, the move off the Brexit bottom was

 

…dominated by just a few sectors, the strongest of them biotech, up over 20%, as represented by the iShares NASDAQ Biotech ETF (NASDAQ:IBB).…Among the worst performing sectors … is the telecoms, represented by the iShares U.S. Telecommunications ETF (NYSE:IYZ).  The group has been flat to slightly higher in that time frame, and our thinking is that a simple sector rotation will inevitably unfold that has the two reverse roles.

 

And so it was.

 

Today, the IYZs go for $2.45, while the IBBs fetch just $0.74.  Sell the former and buy back the latter and you come away with a fancy $1.96, or, accounting for minimal commissions, 1207% – on nothing down!

 

Strawberry banana smoothie.

4

We’re going to examine in greater detail the above-discussed trading range, the better to exploit it when the breakout comes.

 

So let’s establish a few parameters.

 

To begin, consider the even-keeled action of the Dow Industrials over the last two months, which have traded in a tight 0.8% range higher or lower for the last eight weeks (see chart at top).

 

Against that, have a look at the entirely unstable action in the oil sector for that period.  Here is oil for the last three months –

5

Since the beginning of June, crude has bounced higher or lower by more than 10% from its midpoint axis in the $44 area (black line).

 

And that’s outstanding.

 

Moreover, the break below the 50 day moving average, circled in red, is likely to be an interim nail in the barrel for crude, and it’s probable we’ll see the commodity retest its last retracement lows in the $40 area.

 

Of course, the downtrend is creating headwinds for the energy sector as a group, but it’s positively wreaking havoc on an already reeling oil services sector.

 

Have a look below at the PHLX Oil Service Index (NASDAQ:OSX) for the last half year, and pay close attention to the ‘rounding top’ action of the entire period (in blue).

 

[The index, for those unfamiliar, is a composite of fifteen of the largest oil services companies, including Halliburton (NYSE:HAL), Schlumberger (NYSE:SLB) and Transocean (NYSE:RIG), among others.]

6

The technicals are altogether negative here, with

 

1) Recent support breaking down (in red),

2) Price dropping below all her salient moving averages,

3) All the MAs themselves unfurled and trending lower, and

4) RSI and MACD plumbing ever deeper below their respective waterlines (in green).

 

In a word, it’s bad.

 

And we’re going to play it as follows.

 

First, we’re going to hedge the negative outcome we see for OSX against a firmer future for the Dow Jones Industrial Average, a pillar of stability over the last eight weeks.

 

We’ll go long PUTs on OSX and short PUTs on the Dow for the next six months, and it looks like this –

- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]

Many happy returns,

 

Matt McAbby

Share your thoughts...

We encourage people to join in on the discussion. Please keep in mind however, that all comments are moderated according to our comment policy, and all links are nofollow. Let's keep the conversation professional and meaningful.