Sell the Market (CBOE,FXI)
Here at Normandy, one of the means we employ to determine the health of the market is to examine the shares of the world’s major stock exchanges.
The thinking is straightforward.
When the markets themselves are profitable and their shares are rising, it’s a sign of good things to come. When they start to spin their wheels or outright decline, we take it as an ominous signal that weakness likely lies ahead for the major averages, as well.
So how do things look today, with the Dow and NASDAQ and various other world indices at all-time highs?
Let’s have a look at the equities behind several of the world’s largest stock exchanges to gain a better understanding of the state of our market.
We’ll start with the largest of them all, the Intercontinental Exchange Inc. (NYSE:ICE), a company with a market cap of nearly $40 billion that owns the New York Stock Exchange as well as another eight futures and derivatives exchanges worldwide.
The stock carries a nominal 1.20% dividend yield and trades with a P/E of 25.64.
Here’s a look at her daily chart for the last three years –
Shares of ICE rose in an even trading channel for the better part of three years (in red). And then, in June, everything went haywire (blue circle). The stock rose like a Moet champagne cork in an Ivy League finals club, breaking above the trend channel and losing all sense of contact with her long term moving average (in yellow).
As for that moving average, ICE shares have not returned to touch that line since April of 2016. In short, they’re long overdue. And we believe the recent overbought RSI read (in green) indicates that’s precisely where we’re now headed.
Next up is the Chicago Board Options Exchange (NASDAQ:CBOE) daily chart for the same time frame. Here, too, note the long term trend channel that was sundered this spring.
CBOE has a market cap of $10.6 billion, trades with a P/E of 51 and carries a dividend yield of 1.06%.
Take a look –
The CBOE’s wild ascent – some 50% since the November election – has been as good as or better than all the manic gains pocketed by the internet/tech giants over the same period.
But CBOE shares got toppy as early as December, and again in June, when the Relative Strength Indicator (RSI) pierced decisively above the overbought 80 line (in green).
We consider it significant that the spike above the trend channel was even more dramatic than the previous ICE example (in blue) and has put us on alert for an opportunity to call an intermediate top for the shares.
- Shares of Germany’s Deutsche Boerse in Frankfurt (OTC:DBOEF) show the same dramatic rise, with the company’s market cap gaining 50% since mid-October to stand at a current $20 billion.
- NASDAQ Inc. (NASDAQ:NDAQ), a company with a $12 billion market cap and a whoppingly fat P/E of 88.9 looks equally stretched.
- Futures giant, CME Group (NASDAQ:CME) and fixed income trading operators MarketAxess Holdings, also qualify as overbought, ridiculously valuated and pharmaceutically erect.
As you can see, owning the actual trading apparatus can be as good an investment as the stocks that trade on its platform.
So where do we go with this?
Before we get to our trade for the week, please pay attention to the action required on the following open initiatives.
We start with a trade that was opened way back in June of 2015 in a letter called China at New Highs? Buy China! There, we urged you to purchase the FXI January (2017) 51 CALL for $5.20 and sell the FXI June 44 PUT for $0.22, the July 44 PUT for $0.48, the August 44 PUT for $0.81, and the November 44 PUT for $1.56. Total debit on the trade was $2.13.
As it turned out, we ended up buying the shares.
But today, some 24 months later, after a raft of options selling that we outlined in The Urban Banking Reversal, we have turned a profit.
The sold options gave us a total credit of $977 (see here for details). And today we sell the shares.
With FXI now going for $42.04, we escape with our arses bloodied but not gibbeted.
Loss on the shares is $588 (3 lots), initial debit another $213, while the sold options offer us a credit of $977, for a total profit of $176.
Take the money and run.
Sticking with China, we also recommend you close your May 30th trade from a letter entitled From Rio to Shanghai. There, we suggested buying the FXI January 18th (2019) 40 Call for $4.05 and selling the FXI January 18th (2019) 40 PUT for $4.60. Total credit on the trade was $0.55.
The Chinese market snapped smartly higher in the last week and appears due for a rest.
For that reason, we feel it’s prudent to cash out with what we’ve got and consider reinstating the trade on a potential pullback.
The CALLs currently sell for $4.50 and the PUTs go for $3.95. Sell the former and buy back the latter, and you net (including your original credit) $1.10 on nothing laid out. Adjusted for minimal commissions offers you a return of 633% in less than two months.
This week we’re moving on the notion that the market stocks we discussed above have reached an intermediate peak and are due to decline or move sideways over the near term.
We’re especially skeptical of the CBOE’s prospects, and for that reason we’re recommending selling a CALL spread on the January expiry and using the funds to purchase a December PUT.
The details go like this –- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
With kind regards,
Hugh L. O’Haynew