Goldman Sachs. (GS)
(3/30/07)

I've been watching GS for a while for a possible top to its bull pattern from 2002, particularly in the recent recovery from the February 22-March 5 sell-off.  That recovery has so far played out correctively, and as such, a potentially profitable shorting opportunity is being indicated.  My suggestion would be to go the options route, given the price of the stock, and the amount of risk to manage if the outlook is incorrect.  While the Put options are underpriced on a volatility basis, the actual contract prices do reflect the high price of the stock, something to consider if you go with a different Put than the one I suggest.  

As far as the overall wave pattern, the monthly chart shows a 9-wave advance from the October 2002 low of 58.57.  9-wave advances are somewhat characteristic of bull market moves above Minor degree, usually with the fifth wave extended, and the internal third wave patterns of the fifth wave also extended.  The wave pattern for GS displays all these characteristics.  Also, the major and internal wave counts work with a top considered at the 222.75 high of February 22.  This is also a key date of course, since it was the same day that most of the averages made their highs before the correction.  As the daily chart suggests, the decline from Feb. 22 to March 5 is countable as a Wave 1 down, and if a top is in place, it would be Wave 1 within a larger Wave (A).  Assuming the larger intermediate degree count is correct, Wave (A) would terminate around the July 2006 lows, in the 148-145 area.  A longer-term bear market would see the stock return to about 94 in Wave (C).  Before getting excited, keep in mind it took almost five years for the bull market to play out, and that such a low, while perhaps not taking as long, would still be some time away.  Nearer-term downside targets are noted in the daily chart.

A few caveats.  First, the stock did manage a move just above the .618 retracement of the Wave 1 correction when it got to 212, and while the recovery pattern has been a fairly distinct zigzag, it is possible for it to extend in a combination.  The stock does tend to follow the action in the SPX, so this cannot be ruled out.  If it does extend, resistance areas lie at 215 and 220.  Key resistance is of course the 222.75 high itself, which if violated, does change the scenario.  For the moment, that violation doesn't appear likely.  Unless you're willing to ride out some volatility even with a Put option, a break below 197 argues against the combination pattern, and a break below the 189.85 low would confirm the next leg down is in effect.  It's your choice, therefore, on how much risk you want to take.

As far as an option play, you can look at the October 2007 $195 Put (symbol GPYVS), which was selling for $9.50.  This is more out of the money than we usually like for Delta, but it is also underpriced with respect to volatility, so that is the trade-off.  Because the stock does tend to make big daily moves, even the cheaper options are decently responsive.  In the end, it's a matter of how much leverage you want, and what you can spend and risk.

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