New Trade – Spray on $TAN

by Enis August 12, 2014 1:10 pm • Commentary

TAN’s technical situation remains quite precarious, as the solar ETF was rejected today from its 50 day moving average, and is now back below its 200 day ma:

TAN daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg
TAN daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg

I discussed the technical setup in TAN in a CotD post on July 31st, with the following takeaway:

More concerning today is that the ETF is breaking its 200 day moving average, which was briefly breached in mid-May before quickly bouncing.  This break is more serious given that it occurs after serious underperformance in the sector relative to the broader market.  Fund managers have been paring back exposure for many months now, so further market weakness likely means a more serious selloff in TAN.

Despite this break of the uptrend, implied volatility in TAN is still near a 1 year low, indicating relatively cheap protection:

30 day implied volatility in TAN, Courtesy of Bloomberg

With the trend break and relatively cheap options pricing, TAN protection here makes sense for longs.  We don’t have any position, but the short-term technical situation in the sector looks like a setup for further weakness. We may be interested in a short targeting a move down to the 34-36 area but not on a day like today. Perhaps on a bounce back towards 40.50-41.

Well, in the past 2 weeks, we have indeed seen a situation where TAN bounced back up into the resistance area (actually rallying a bit further than we expected).  Given today’s failure of both ma’s and the prior break from late July on large volume, we are interested in a potential reversal in the coming weeks.  However, choosing the appropriate structure is a bit more difficult, especially given the wide options bid to ask.  

I also wanted to take a look at the components within TAN to get a sense for what’s leading the weakness.  The first 3 components, SCTY, SUNE, and FSLR, which make up about 25% of TAN’s weighting, have actually been among the strongest in the sector.  Here is the full list of members and weighting for TAN:

Screen Shot 2014-08-12 at 11.50.16 AM

Screen Shot 2014-08-12 at 11.50.36 AM

The weakness in TAN has been led by many of the Chinese manufacturers, many of which peaked in February and March with TAN, and have been in downtrends ever since.  We have always been of the opinion that the better investments within the solar industry are in servicing, financing, and developing projects, rather than in the manufacturing and components side of the business.  In addition, the trade dispute between the U.S. and China over solar equipment tariffs has been an overhang for the Chinese manufacturers for the past few months.  More bad news might be expected on that front given the recent treatment of U.S. technology companies by Chinese regulators.

Given that Chinese-related companies make up nearly 50% of the weighting of TAN, those issues are likely to continue to weigh on the ETF.

TAN implied volatility remains near 1 year lows:

[caption id="attachment_44115" align="aligncenter" width="600"]TAN 30 day implied volatility, Courtesy of Bloomberg TAN 30 day implied volatility, Courtesy of Bloomberg[/caption]

However, vertical put spreads on their own are quite expensive since the absolute level of volatility is still in the high 30’s.  As a result, we’re going to put on a long premium trade, but chose a calendar instead of a put spread:

TRADE:  TAN ($40.71) Bought the Sept/Oct 39 Put Calendar for $0.78

-Sold to Open 1 Sept 39 Put at 1.24

-Bought to Open 1 Oct 39 Put for 2.02

Break-Even on Sept Expiration:

-Max profits with stock at $39 on Sept expiration.

-losses of up to $0.78 if stock is significantly higher or lower than $39 on Sept expiration.

Rationale:  TAN has found support near $37.50 throughout the past 6 months, so we would be surprised to see an immediate break of that support level on the next move lower.  On the upside, we expect the $41.50-$42 resistance area to hold, though we’ll get out of the trade for a loss if TAN breaks above there.  As a result, we preferred a put calendar where time works in our favor in the near-term, but cheapens our Oct 39 put.  This trade is more a time decay trade for the next month, but picks up delta if TAN remains above $39 as we approach Sept expiration.