Ways to play the risk-off bubble

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I will be the first to admit when I am wrong. Less than two months ago, I stated we were at the beginnings of a new bull market because the economy was improving and valuations were low. That now appears to have been premature because the demons of the 2008 crash have not yet been exorcised.

The real issue is that we're in the midst of an unusual bubble, one that's just as irrational as any other: a risk-aversion bubble. Most people focus on the risk-taking element of capitalism, but it also applies to self-preservation. Just as sentiment can go too far in the direction of euphoria, the pendulum can swing back in the opposite direction, as we are seeing now.

Treasury yields are the main indicator to gauge this trend. After staging an abortive attempt to rebound in March, they have now thudded back down to last year's support levels. I expect them to churn in a range for months or make new lows, taking stocks along for the ride. This will probably result in an annoying back-and-forth rather than an outright selloff. In other words, there is no trend to trade.

One pattern that has emerged, however, is liquidations in stocks that were formerly one-way bullish growth names, such as United Rentals (URI), Sturm Ruger (RGR), and Nu Skin Enterprises (NUS). The fundamentals in these companies remain excellent, but their charts have broken down, which suggests that investors simply don't want to own stocks that are sitting on huge gains when the rest of the market is weak.

In my view, the best strategy now is to look for other high-flyers that have lost their mojo and are now potential shorts. Starting from researchLAB's bullish chart box, I clicked on the MORE button to find stocks that have been trending higher. I then modified the criteria:

• Remove: Last > 20-Day Moving Average
• Add: High > 50-Day Moving Average
• Add: Last < 50-Day Moving Average
• Add: Last > 100-Day Moving Average

(For a shortcut to this screener, click here )

Once these stocks were loaded, I clicked on the 12-Month column to sort by descending values. The resulting list shows stocks that have rallied hard in the last year but have now showing signs of reversal. (Adding the criteria of a "high" above the 50-day but a "last" below the 50-day, we find stocks with potentially bearish "shooting-star" candlesticks. These tried and failed to close above that key level.)

Based on yesterday's closing values, here are some results:

Visa (V): Yes, it's been a beautiful trade, but the stock has been making a nice rounded top. It made a lower low on Friday and now looks to be making a higher low below the 50-day. The $119-$120 area level appears to be the new resistance. V also has weekly options, and the short-term in-the-money puts are cheap.

Discover Financial Services (DFS): Similar story to V. The option liquidity isn't as deep, but the 32/30 put spreads in June or July potentially make sense.

Yum Brands (YUM): This stock has held up remarkably well given all the worries about China, but now it, too, is making lower lows and meeting resistance at the 50-day. The 67.50/62.50 put spreads in June or July look particularly interesting. Volatility is historically low in this name, so if it tanks you could also benefit from a pop in vol.

UnitedHealth (UNH):
Nice double-top around $59. The entire health-insurance space has been flashing warning signs recently as medical costs climb. The only proviso is that the Supreme Court could give the industry a boost by the end of June if it overturns Obamacare. UNH could potentially be shorted for the next two weeks. Then, if the justices rule against the law, sell the pop after the news comes out.

Other names that came up on my bearish-reversal screener included Artic Cat (ACAT), Dollar General (DG), O'Reilly Automotive (ORLY), and Tyco International (TYC).

(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of May 23.)



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.


This article appears in: Investing , Options

Referenced Stocks: DFS , UNH , V , YUM

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