Hello Traders,

Tonight I am going to try to address the following question. Did the Financials Breakout? So, let’s get started.

Over the last few weeks I have been following the Financial sector and sitting on the sideline. I am kicking myself a little for not buying some of them as I have seen the rise occurring. I held off because I had started a pretty good sized position relative to my portfolio in the short bond trade, and the correlation between them being high forced me to sit on my hands to limit the exposure in one thesis. Now that the bonds have made a solid move and I am pretty much in with house money, I am looking for some exposure to the financials to continue with the thesis of a rising interest rate environment. I do not want to enter into a head fake by the financials though. With that said I am going to look at the following charts and continue to evaluate the diversification from bonds into the Financial Sector.

The discussion now turns to, “Have the Financials broke out?” I am not only having this discussion to try to prove a point, but to develop a discussion, and to prove to myself how much risk I want to put on in this position. I am not one to be sold on the market has to sell off because it is at a high, because much of my trading is done looking for breakout positions, and many of them are breaking out of highs. The caution I have is the valuation that goes along with the breakout. It (market valuations) might be getting a little bit high, but I am willing to live with that in a growing economy. Time will play out with that and I am going to trade a convicted breakout (in the financials) as you always should. I am going to post eight screenshots of the Financials, Bonds, and the Dollar to try to get a visual to aid in the discussion. A special thanks to TD Ameritrade for the awesome Prophet Charts.

XLF

FAS

SCHW

GS

BAC

TLT

Dollar

FXE

I am going to summarize the screenshots. I am still a little cautious of the breakout in the sector, but I feel there is some conviction. The question lies if the breakout is strictly due to the bond sell off and rising rates. I strongly feel that the financial sector is going to benefit starting this quarter and will be reflected in their earnings. The problem is entry timing. Is this the right time, or is there going to be a pull back? XLF failed to have a break out above my buy point in the chart (Green dotted line). The XLF ETF did not have convincing volume either. On the other hand FAS did breakout and close about my buy point, but again on low volume. SCHW which is one of the asset accumulators that I follow as well as ETFC, AMTD, and BX have stalled a little even with the move lower in the bonds. I like the move that BAC has made to the upside, and I really liked the above average volume. If this conviction continues in that name as well as the other big banks like C, WFC, and JPM you could see the ETFs move much higher.  I included TLT in the charts to show you the continued move down in bonds, this could just be getting started, but I think you are starting to see a trading range getting established.  I have been wanting to see this so that I can comfortably sell more premium against my short bond positions that I currently have on. That range looks to have a new top at about 122 and longer term support to the downside between here down to 117(a longer term support). The last two charts included are the cause for concern that I have with this rally in financials and the sell off in bonds. This whole move down in bonds was closely followed with he dollar getting weak starting in mid April.  TLT was at about 130 when the dollar weakness started and now around 118 as the dollar softened. Today a very strong reversal happened in the dollar and this was also versus the other currencies. Consider the FXE (Dollar/Euro). If you dig a little deeper to see if this dollar move had teeth you could look at GLD, SLV, USO, and DBA. All dollar based commodities had large reversals from their recent strength. I have been saying for about two weeks now that I wanted to see how this week plays out with retail earnings, the FED speak, and in general how the market reacts. It seems the ECB is getting after the QE program they have implemented, and Greece has managed to move back into the news. All catalyst for a stronger dollar. Will this manipulate the dollar to strengthen again and deflate the dollar based assets? I will be anxious to see this play out. This is a lot of general information that I just threw out there. I suppose I should wrap it up now and put a bow on it.

I really like the financials at this point, as well as bonds to remain weak. I feel the bonds have made a significant move, and if they break 117 (TLT) to the down side they could continue.  I believe that they will trade in a range between 117 and 122 as long as the dollar remains fairly stable at these levels. If this holds true, I think you will see that the strength in financial sector continues, but if the dollar rallies the financials as well as the rest of the market could be challenged. I think that will actually be a great opportunity to get long this sector and would be ideal vs trying to get long this weak breakout. If the conviction in this rally continues and you see XLF and the individual positions break out with the power of BAC today with its move higher with large volume (remember 1 day is not a breakout), and a follow through day would be ideal. If this occurs I will be entering a long financial position, but remember I will use risk control with size due to the short position on in bonds. I don’t want to extend myself to much into that rally. Remember, one method of risk control is by managing how much money you have tied to correlated items all traded in the same direction. The dollar action today and the extreme low volatility have me somewhat skeptical, but I am ready to trade a breakout.

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Happy Trading,

Option Coach