Monday, March 18, 2013

BOOM: A lower liquidity trade

Update: BOOM on March 27 fell below its 10-day price channel, crossing the lower boundary at $17.46. My position was in long shares, and they were sold at $17.45 for a 4.8% loss from the initial entry price. The position had been added to once as the price rose, and the loss was 5.7% from the average basis of the whole position.

Dynamic Materials Corp. (BOOM) moved above it's 20- and 55-day price channels on Friday, and confirmed the bull signal by trading above the $17.91 breakout level today.

Only three of the 11 breakouts that survived my screens were confirmed today by trading above their breakout levels. The markets as a whole are down sharply -- Cyprus, anyone? -- and most of Friday's breakouts have seen sharp reversals.

Of the three that were confirmed, it's a case of Goldilocks and the Three Bears.

The one with the highest volume, OGE, ended up closing Friday 10.6% above the prior day's close. It's porridge was too hot. I tend to avoid jumping in after such a large move, on grounds that most of the action has already happened and there will most likely be a decline in trading interest for awhile.

The one with the lowest volume, WTM, has nearly a 60% success rate in upside breakouts in the past four years. But since the current leg up began, losing breakouts have outnumbered winners 2:1. WTM's porridge is too cold.

That leaves BOOM, with volume in the middle. And its porridge might be just right.

BOOM has previously broken out to the upside 11 times since the broad markets began their post-recession recovery in early 2009. Eight were profitable, with an average yield of 19.4%. That's extremely high.

The price has been declining since early 2011 in a series of zig-zags. The most recent move is an upward zag that began from $12.18 in late October. In that period BOOM has broken out to the upside only once before. The trade was profitable, returning 16.2%.

In a still broader view, BOOM has been marching in place since recovering in May 2009 from the recession crash, ranging from $12 to $14 as a floor and $24 to $30 for the ceiling. In that broad pattern it has set both a lower low and a lower high, so the stock has clearly been in a downtrend for the past two years.

Dynamic Materials is one one of those companies, difficult for outsiders to understand, that makes stuff that other companies use in their processes. Dynamic's niche is explosion-welded clad metal plates for the oil and gas industry.

BOOM doesn't have a wide following among analysts. The less-than-a-handful who track the company collectively fall in with a 50% enthusiasm rating.

Dynamic Materials reports return on equity of 8.2%, respectable but not outstanding, with debt amounting to 23% of equity, slightly higher than I like but by no means is it awful.

The company has shown only one loss in the last 12 quarters, and that was back in 2010. Earnings tend to peak in the third quarter, and the 2012 Q3 was below its 2011 counterpart. The 2012 Q4 is also below its 2011 counterpart.

Earnings have surprised to the upside 10 times, and to the downside twice.

Institutions own 69% of shares and the price is near par; it takes $1.22 in shares to control a dollar in sales.

BOOM on average trades 54,000 shares a day. It has a moderate selection strike prices, but the open interest is lower than I'm willing to trade. The front-month  at-the-money bid/ask spread on calls is 56%, another reason not even to come close to these options.

However, although the options don't meet my criteria for trading, they can still be of some use in analysis.

Implied volatility is running at 31%, near the bottom of the six-month range. Volatility has been declining in a series of zig-zag steps since mid-February.

In several places that follow I'll use the percentage "68.2%". In statistics, one standard deviation encompasses 68.2% of trades surrounding a reference prices. It measures confidence that the actual outcome will fall within the boundaries.

Options are pricing in confidence that 68.2% of trades over the next month will fall between $16.57 and $19.83, for a potential gain or loss of 9%, and between $17.41 and $18.99 over the next week.

Trading in options today is below their five-day average volume, with a bias toward speculation to the upside. Calls are at 81% of average volume, and puts at 49%.

The fair-price zone on today's 30-minute chart runs from $18.18 to $18.36, encompassing 68.2% of trades surrounding the most-traded price, $18.20.

The fact that, 2-1/2 hours into the trading day, the most-traded price is so near the floor of the zone suggests that traders have been making runs toward the upside, but have lacked the power to succeed.

Dynamic Materials next publishes earnings on April 29. The stock goes ex-dividend March 26 for a quarterly payout yielding 0.88% annualized at today's prices.

Decision for my account: There's no reason not to open a bull position in BOOM, If I'm comfortable with the low liquidity and the lacks of options to provide leverage and thereby boost the potential yield.

I've opened a bull position in BOOM, structuring it as long shares.

References

My trading rules can be read here.  A discussion of recent modifications to my trading methods, which haven't yet been incorporated in the original write-up, can be found here.

And the classic Turtle Trading rules on which my rules are based can be read here.

Disclaimer
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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