Shopping for Soap at Disney World: Discretionary Spending over Staples

• Posted by Greg Harmon
• on July 5th, 2011

Last week teh Cuonsumer Discretionay Select Sector SPDR (ticker: $XLY) hit an all time high. While the Consumer Staples Select Sector SPDR (ticker: $XLP) is close by it is lagging. This comes as no surprise to me. With all the meal packages at the resorts and the soap and shampoo in the hotel room there is no need to spend money on Staples if you can go on vacation at Disneyland and get all those things thrown in with the package. This is being reflected in the prices of the ETF’s as well. Below is a ratio chart of the weekly price of $XLY vs $XLP. Notice that after testing the nearly 3 year trend line

it has bounced higher over the last two weeks on increasing volume and is now near resistance since March, at a ratio of 1.31. It has a rising Relative Strength index (RSI) and a Moving Average Convergence Divergence (MACD) indicator that is about to cross positive. If the ratio gets above 1.31 there is resistance at a ratio of 1.356 and above that a breakout of an ascending triangle of more than a year. The initial break creates an opportunity to cheat and get into the trade early. The target for the breakout of the triangle would be a ratio of 1.637, where the ratio spent most of the period between 2005 and 2008. This creates a great pairs trade opportunity.

Trade Idea: Buy 3 XLY and sell short 4 XLP on a break above the 1.31 ratio with a stop at 1.29

By buying the XLY against the XLP capital committed is negligible. Using the closing prices of the two ETF’s from Friday to approximate, a move in the ratio to 1.356 would create a profit of about $4.35 and all the way to 1.637 profit of about $31, against risk of $1.95 or a reward to risk ratio of 2.23:1 on the shorter cheating entry, and over 15:1 on the bigger trade.

If you were to wait until a break of 1.356 to enter the reward is reduced to just over $26 and using a 1.31 as a stop, risk is about $4.35, for a reward to risk ratio of just under 6:1. Your choice, be ready for Monday or wait for the solid break.

(As always you can see details of individual charts and more on my StockTwits feed and on chartly.)

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