The "bullish triangle" and the "bearish triangle" are two patterns that point and figure aficionados look for. Why is that? You may ask. A Purdue University study by Professor Earl Davis found that on average, the "bullish triangle" was profitable 71.4% of the time with an average gain of 30.9% in a 5.4 month time frame. The "bearish triangle" was profitable 87.5% of the time, with an average gain of 33.3% in a 2.5 month time frame. Those that understand "time is money" are undoubtedly wanting to see a downward move take place (bite your tongue!) in the insurance sector as they often times experience greater gains in a shorter amount of time.
S&P Insurance Index - $5 box
The "triangle" formation is easily recognizable on the point and figure chart. you can really see that there's some disagreement between supply (O's) and demand (X's). The highs are getting lower and the lows are getting higher. Looks like some pressure is building and when that pressure releases itself a major move often times results (according to the Purdue University study).
Right now, the triangle is just that. A triangle. Neither bullish nor bearish at this point. Current technicals would have a "bullish triangle" take place with a trade at $735. The "bearish triangle" would take place with a trade at $700.
Is there an options strategy available where I can take advantage of uncertainty or what looks like building disagreement between the bulls and bears, yet still potentially profit should a major move take place once we get a break? Yes! The strangle or straddle.
Can I use the Purdue University study to help me determine what length of expiration to buy based on the statistical study? Yes! The bullish phase might take 5.4 months, while the bearish phase might take just 2.5 months.
Trading options on the S&P Insurance Index (IUX.X) looks terrible as it relates to options. What we need to do is take some time (I think the weekend should be good) and come up with a couple of stocks where their chart patterns are very similar to that of the IUX.X. Then trade options there.
Ask the Analyst
Eric Utley is already hard at work on this project; he's the one that found the pattern when he was doing his hand charting (the guy has too much time on his hands). He will be covering this topic in his weekend's "Ask the Analyst" column on OptionInvestor.com.
Questions from readers
Question: For monthly income, would you suggest a Bond Fund or Corporate Bonds? I held a California Tax Free Bond fund for a few years and withdrew the interest monthly. Over the past few months the investment increased by about $8,000, the chart looked to be topping so I sold the fund to lock in my profits.
Jeff's first thought- This subscriber made some nice gains and got monthly income in bonds while dodging a broader market stock decline. Not sure if subscriber knows that they may have been trading bond YIELD charts and bought higher YIELD. Then price of her bonds rose (capital gain) as market gobbled up bonds (driving YIELD lower).
Question: Now, I wonder if it is time to reinvest in Tax Free Bonds or just a Bond Fund.
Jeff's second thought - What is the subscribers risk/reward profile? Do they count on the monthly income? How much income to they need? The income we get from a bond fund, is it within their risk profile? California-tax free. Is the subscriber a resident of California? Does the subscriber have tax issues where they prefer double-tax-free status?
Question: Could you recommend a book or a course that would introduce me to bonds and how to trade them?
Jeff's 3rd thought - No. Sorry I don't know of any good books on trading bonds. I actually prefer a mutual fund for my bond fund investing. When I did manage individual money and trade bonds for account, we started with $1,000,000 and worked from there. Spreading risk in bonds is critical and a bond fund is the best place to start. I only buy bond funds in my retirement account when I'm waiting out a market decline. I can't short or buy puts in my IRA. However, I'll short/put like a madman in my regular trading account when it comes to stocks.
Why did I post the bond question?
The bond question is perhaps the BEST question I've gotten in the past 6-months! Everyone's questions are great, but this one ranks as the "best." It's also the first. Do you see how this person actually has to think about risk/reward and perhaps meeting monthly income needs? This is EXACTLY what institutional market participants do every day.
Is the risk/reward in stocks worth the risk/reward and income from bonds for the dollar I invest or put to work today. Where do I go? I the tax-free the place? Is the corporate bond the place. Do I go with A-rated corporate or go down the scale to "junk?" I understand that with bonds as well as with stocks, the more riskier the bond is perceived, the HIGHER yield it will pay!
Believe it or not, we can tackle this question and look at some bond mutual funds and their point and figure charts.
If Jeff Bailey is correct at the 30-year Treasury YIELD ($TYX.X) is riskier than the 13-week Note ($IRX.X) then I begin there. It is entirely possible that we can spread some cash around and perhaps look to invest some money in a HIGH YIELD bond fund, put some money to work in a Corporate Bond Fund, and perhaps put some money into a Double-tax-free Bond Fund. But before I do that, I need to know the risk profile of the subscriber.