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By: Chris Rowe — June 11, 2009

Special Market Commentary

Teeka Tiwari here, from Sector Hunter.

Chris reached out to me this week and asked if I would put a special report together for his members about some upcoming shorting opportunities we’re seeing over at Sector Hunter.

I must say that it’s an honor and a pleasure to be invited to share this commentary with you.  I want to talk to you about three sectors that are getting very close to posting a sell signal, and on top of that I also want to share some prospective option plays that you can use to profit from those moves.

While demand is still very much in control of this market, we are starting to see some worrying signs of over-enthusiasm. The beauty of our sector signals that we use at Sector Hunter is that we don’t have to try and predict when these sectors are going to be good shorts. All we have to do is wait for the sell signal to be given by the group.

When the signal is given, Chris will follow up with you letting you know specifically which options to buy, and when to sell. For now I just want to get some of these potential trades on your radar.

Every fund manager in the world right now is clamoring to get into the stock market for fear that the indexes will continue going higher without them.  This “buy with abandon” approach is deemed necessary because they are deathly afraid of the market moving higher without them.

It’s this type of buying that result in sectors becoming dangerously over bought.  Buying can get over done the same way selling can get over done.  Even in a raging bull market, we will see frequent sharp pull backs.  So we don’t need to debate if a new bull market is upon us or not.  Maybe it is and maybe it isn’t, but what we do know is that nothing goes straight up.

Everything fluctuates between the twin forces of greed and fear.  We see these two forces play out in the form of rallies and sell-offs.  Right now, the markets are in full bore bull mode, but we know from our study of markets that this condition doesn’t last forever.  Through indicators that we use at Sector Hunter we can determine when a sector has the highest probability of bottoming and topping.

(Want to find out more exactly how Sector Hunter does this? Join me at the “Trade Like a Monster” event being put on by Trade Monster down in San Antonio, Texas on June 20th.  Click here for more details.)

Back in February and March of this year, many bottoming signals were triggered and the resulting trades that came from those signals have proven to be very profitable.  But we are in a different market now; the next major series of moves that the system is looking for are on the downside, not the upside.

As such, the system has flagged several sectors that are exhibiting extremely over bought levels that could prove to be excellent shorting candidates.  Let me be clear, these sectors have not reversed to a bearish condition yet.

There is an important Wall Street aphorism that says "over bought (or over sold) doesn’t mean over!"  Sectors can stay overbought or oversold for extended periods of time.  In an especially strong up move, sectors can even trigger a sell signal then quickly reverse higher.  So it’s important to use stop losses.  This way when the sector puts in another sell signal you are in a position to take advantage of it.

In the market, we deal with odds and probabilities, not certain outcomes.  What we look to do is use a system that puts the odds as strongly as possible in our favor.  Signal reversals and stops getting hit are part of the professional trading game.  It’s obeying the stops and the reversals that is the mark of a disciplined trader.

With that in mind, I want to bring three groups to your attention that are shaping up to be fantastic shorts once they put in the appropriate sell signal.  Let me reiterate: don’t short them yet, because demand is still in control of these groups and they could go higher!  Chris will alert you once we see sell signals given on each group.

The first group we want to look at is Oil Service.  This sector contains companies that service the oil industry with drill ships, transportation services, off shore oil rigs etc.  Oil Service is a sector that is notorious for massive volatility ... the upside and downside swings in this group can be breathtaking.

The current bullish readings in the Oil Service sector are very near those reached at the peak of the market in 1997 and 2005.  After those peaks were reached, we witnessed a devastating sell-off in oil service stocks.

The three best pure play ETFs in the space are:

1.  streetTRACKS SPDR Oil & Gas Equip & Service ETF (Symbol: XES)          
2.  Oil Service HOLDRS (Symbol: OIH)        
3.  DJ US Oil Equipment & Services Index Fund (Symbol: IEZ)

When we get the sell signal, any one of these three ETFs will make an excellent shorting candidate.

We would want to buy PUT options if looking to profit from a downward movement in these ETFs.

When looking to substitute options for stock the typical rule of thumb that we use is 5-6 months out and 5 points in the money. By buying 5 points in the money we get a “Delta” that is closer to 1:1 which means we’ll be profitable faster. By buying 5-6 months of time we give the trade time to work. Delta is simply the measurement of how closely the option mimics the stock price. A 1:1 Delta means that for every $1 the stock moves the option will also move $1.

Now remember: the sell signal has not been given yet, and when the signal is given Chris may end up recommending a different series of options depending upon how long it takes for the sector sell signal to trigger and how high these stocks go between now and then.

But the following potential option trades will give you a good idea of what you should be looking at.

We like to buy 5 points in the money, but sometimes no option exists to do so. This is the case with options for streetTRACKS SPDR Oil & Gas Equip & Service ETF. In a case like this we buy what’s available, and in this case that happens to be “at the money” options. “At the money” simply means that the option’s strike price and the stock’s price are the same.

Below are 3 PUT options that you could use in lieu of shorting the ETFs:

1.  streetTRACKS SPDR Oil & Gas Equip & Service ETF (XES)

  • December 2009 $25 PUTS (Symbol: GNPXY)

        
2.  Oil Service HOLDRS (OIH)

  • October 2009 $120 PUTS (Symbol: OIHVD)

     
3.  DJ US Oil Equipment & Services Index Fund (IEZ)

  • October 2009 $43 PUTS (IEZVQ)

For those looking to take on a little more risk, below are three Oil Service stocks that could be profitable shorts when the sector reverses to a sell signal ...

1.  Oceaneering International Inc (Symbol: OII)
2.  Tidewater Inc (Symbol: TDW)
3.  Baker Hughes Inc (Symbol: BHI)

Below are 3 PUT options that you could use in lieu of shorting the Stocks:

1.  Oceaneering International Inc (Symbol: OII)

  • October 2009 $60 PUTS (OIIVL)

2.  Tidewater Inc (Symbol: TDW)

  • October 2009 $55 PUTS (TDWVK)

3.  Baker Hughes Inc (Symbol: BHI)

  • October 2009 $45 PUTS (BIJVI)

The last time we got a short sale Alert on this group was back on July 3rd, 2008 ...

Above is a copy of the actual Alert that went out on July 3rd, 2008.  As you can see, the gains from the short sale trades in this sector were tremendous!  The Alert shows the price we got short at (far right) and the current price as of Monday, June 8th, 2009.  If you look at the subsequent lows each stock experienced after the July 2008 Alert went out, you can see that these stocks and ETFs actually went far, far lower.

The next group that needs to be on your radar is the Steel/Iron Sector.  Like the Oil Service sector, this group experiences fantastic upside and downside volatility.  It recently put in a Sell Alert in April, and within two days reversed back to a buy.  This will happen occasionally, but it’s quite a rare event.  The last time, before this, that Steel reversed a Sell Signal was six years ago, back in 2003.

Since the April reversal, the Steel sector has been on a tear, with fund managers clamoring to get back into the sector.  Steel has been this overbought on 8 previous occasions over the last 15 years, so it has a strong record of getting very over bought.  Just as important, though, shortly after reaching such over bought readings the entire sector has experienced broad based vicious sell offs.

The next Sell Alert that hits the Steel/Iron sector will be occurring from the highest level we’ve seen since January 15th of 2008.  You can see in the table below just how profitable those January Alerts were.

There aren’t many ETFs that cover this specific sector, so we only use two:

1.  Market Vector Steel Fund (Symbol: SLX)
2.  SPDR S&P Metals & Mining (XME)

When the sell signal comes, both of these ETFs will represent excellent shorting opportunities.

Below are 2 PUT options that you could use in lieu of shorting the ETFs:

1.  Market Vector Steel Fund (Symbol: SLX)

  • September 2009 PUTS $53 (EZNUA)

2.  SPDR S&P Metals & Mining (XME)

  • September $47 PUTS (XMEXU)

On the stock front, as of the data we have now, three good short side contenders look to be the following:

1.  POSCO (PKX) 
2.  Omega Flex Inc (OFLX)
3.  Gibraltar Industries Inc (ROCK)

All three of these stocks are lagging their peers and are still struggling to break out of their downtrends.  But remember: Steel hasn’t reversed yet!  Steel could go up quite a bit more before it finally weakens.

Below are 2 PUT options that you could use in lieu of shorting the Stocks:

1.  POSCO (PKX)

  • November 2009 $90 PUTS (PKXWR)

2.  Omega Flex Inc (OFLX)

  • Does not trade options

3.  Gibraltar Industries Inc (ROCK)

  • November 2009 $10 PUTS (RUQWB)

The Sell Alerts we saw previous to the most recent Sell Alert reversal were on November 6th, 2008 and January 15th, 2009.  Below is the trade data from those Alerts:

The last sector I’m going to bring to your attention is the red hot Latin American sector.  This is a sector that has been on a bull rampage!  Its most recent readings show the group up near its 2007 peak technical levels.  This is a sector that I happen to like long term, but it doesn’t mean that we can’t take advantage of the pullback when it comes.

Like most of the emerging market plays, this sector is a haven for hot money, and hot money is fast money.  Hedge fund managers bang money in and out of this sector all the time.  We are squarely in the danger zone in Latin American equities, and a reversal from here could be the beginning of a very healthy correction for the group.

Once again we have no idea how long the group will stay overbought, so we'll wait for the reversal signal rather than try to preempt it.

Normally I recommend shorting the weakest stocks and ETFs in a sector. What I’ve found though is that some of the biggest short side gains in this sector have come from stocks and ETFs that were the strongest during the bull move.

This is a function of the capricious nature of the “fast money fever” that grips the exciting emerging market stocks and ETFs. The other issue is one of liquidity, oftentimes the worst performing foreign stocks and ETFs are the most illiquid.

The engine of growth in this area of the world is Brazil and, as such, this is a market that typically fluctuates the most when the sector rotates in and out of favor.  The 3 ETFS that you want to watch in this group are:

1.  iShares Brazil Index (EWZ)      
2.  iShares MSCI Chile Index Fund (ECH)    
3.  SPDR S&P Emerging Latin America (GML)    

Below is 1 PUT option that you could use in lieu of shorting the ETF:

1.  iShares Brazil Index (EWZ) 

  • December $65 PUTS (EWZXM)

    
2.  iShares MSCI Chile Index Fund (ECH) 

  • No options traded

  
3.  SPDR S&P Emerging Latin America (GML)  

  • No options traded

When the group is doing well, these ETFs zoom higher, but when the group's getting beaten up, these ETFs drop like rocks!  There are also Latin American equities that you can short, but for this sector I strongly urge you to stick with the ETFs, simply because the ETFs in this group move like stocks.  For instance, when iShares Brazil Index (EWZ) peaked last year at $100, it then went as low as $30!  That’s a 70% move down on an index!  That’s an astonishing move for an index to experience.

Conclusion

Investing is like big game hunting, it requires preparation, patience and a deep understanding of the habits of your prey. All markets undergo predictable cycles if you know what to look for. Right now the market is screaming over bought warning signals the same way it screamed over sold warning signals back in February and March of this year.

There’s big money to be made on both sides of the market, and while we are not there yet on the short side, we are bloody close! So stay tuned and Chris will have the alerts out to you as soon as the appropriate signals are given.

Let the game come to you!

Big T

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