| pps | psar | macd | obv | h-a trend | ma20 | ma50 | ma200 | |||
|---|---|---|---|---|---|---|---|---|---|---|
| PCLN $388.87 |
Financially, there's nothing not to like about this company, with a return on equity of 50.7% and a debt to equity ratio of only 0.04%. Annual sales have accelerated reliably for the past four years, and second quarter 2010 sales are 27% higher than those of second quarter 2009.
The three signals I follow have been in bull phase since late October (mid-October for the parabolic sar), and the price is above the moving averages for month, quarter and year.
The on-balance volume is trending higher, although not with a spectacularly steep slope, and the short-term Heikin-Ashi trend is up.
On both the fundamentals and the charts, this is a position that I would take in a flash. There's just that pesky earnings announcement to contend with.
Looking back two years, five of the earnings announcements have produced gaps up, and two have seen gaps down. And the gaps tend to be of the OMG-fasten-your-seatbelts variety, not for the faint of heart.
Recent options action has tended to support the bullish case. However, I note that the consensus earnings estimate is 52% higher than the last quarter's earnings, and 37% higher than the year-ago quarter's earnings.
The price/earnings to growth ratio (the PEG) is 1.5, so there's a 50% premium in the price. The forward price/earnings ratio (P/E) is 40.87, meaning that the consensus estimate of quarterly earnings would account for more than half of annual earnings. The comparable quarter a year ago accounted for a third of earnings for the year.
So, the market is setting a high mark, has no doubt priced it in, and will exact punishment should the company fail to hit that mark.
On the Person's chart, the price is midway between the midline and the first upper pivot, giving a price target of $400.80.
Person's Weekly Table
| pps | pps open | upper pivot | lower pivot | |
|---|---|---|---|---|
| PCLN $388.87 | $344.90 oct22 | $400.80 +7.9% | $376.95 -12.5% |
On the weekly Person's chart, the signal turned to bull phase in early July, with a target of $419.75, or 7.9% above Friday's close.
The price is in blue-sky territory -- it has never been this high before. That means no price resistance to the upside except for Friday's high, with is 1¢ above the close.
Reversal Levels
- $388.88, +0.0% (all-time high)
- $388.87 --- You are here.
- $361.74, -7.0% (20-day moving average)
- $342.32, -12.0% (50-day moving average)
- $341.24, -12.3% (oct. swing low)
- $257.57, -33.8% (200-day moving average)
The Bollinger Bands have been expanding, suggesting a continuation of the trend, and the price is just below the upper band, indicating the stock is historically expensive.
Bottom line: There is little in the chart to guide the decision about when to purchase. History suggests there's a likelihood of an upside surprise. However, the high expectations embraced by analysts tell me that there are increased odds of an earnings disappointment. I mean, raise the bar high enough, and the finest Olympic champion will fail to clear it.
The challenge, then, as always is to create measurable risk from unmeasurable uncertainty.
The way to do this is to enter into a bull position, but hedge it on the downside in case of a surprise. An options construct called a vertical provides a way to do this.
I'll go into my planning in some detail, for those who don't regularly do complex option structures.
A vertical involves selling options at one strike price and buying them at another. It limits loss, but also limits profit. Those limits provide measurable certainty. It turns the position into one of risk, the same as life insurance or flipping a coin 100 times.
The stock has been undergoing increasing volatility as measured by the Bollinger Bands. They're becoming wider apart. I find it more profitable to sell higher volatility, so I'll be entering into a vertical that provides me with net income at the outset.
For a short bull vertical, I use put options. The puts I sell will gain value if the price goes up. The puts I buy, at a lower price, will lose value as the price rises.
I like to position my higher strike price -- the options I sell -- below support. In this case I'll use the lower Person's Pivot for support at $376.95. I could just as well use the parabolic sar, at $369.05, or the 20-day moving average, at $361.74.
Strike prices for PCLN are $10 apart, so I sell the $370 put option, and buy the $360 put options.
The stock closed Friday at $388.87.
With this vertical, at expiration on Dec. 17, I am at maximum profit at any point above $370. The stock can lose 4.9%, and I'm still at maximum profit. I hit maximum loss at $360, or 7.4% below the current price. If the stock falls 25% on a huge earnings surprise, my loss is only as though the stock fell 7.4%.
In dollar terms, I get $365 for selling a vertical, and get to keep it if the price remains above $3.70. I have to buy it back for $635 if the price falls below $3.60. So, $635 is my maximum loss.
One way to look it at it is to consider $635 the capital risked, and $365 as the profit on that capital. A successful trade would produce 57% profit, and the amount risked is the equivalent of two shares, roughly. Another way to look at it is a profit of nearly 1% on the 100 shares controlled, over a period of a day or two.
Either way, it's a pretty good trade, although not a spectacular one.
The alternative would be to buy a few shares of this expensive stock, with unlimited reward but unlimited risk. Not something I'm willing to undertake the day that earnings are announced.
One caveat: This stock trades only about 1 million shares a day. Generally, I prefer more liquidity than that. Open interest on the two strike prices in my vertical spread are around 140 each, which is minimally acceptable.
I may decide not to take the trade, frankly. I mean, there has been a lot of upside already realized, and the price is fairly high by all measures. If I trade, it will be in the last half-hour of the market day.
Disclaimer
Tim Bovee, Private Trader tracks the 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.
Abbreviations:
- h-a trend - Heikin-Ashi trend.
- obv - On-Balance Volume.
- pps - Person's Proprietary Signal.
- psar - Parabolic Stop and Reverse
- ma20 - 20-day moving average
- ma50 - 50-day moving average
- ma200 - 200-day moving average
- macd - Moving Average Convergence-Divergence
About the glance: The colors indicate the state of each signal.
- Signal Section:
- pps, psar, macd: green for bull mode, red for bear.
- Confirmation Section:
- obv: green for uptrending, red for downtrending.
- h-a trend: green for uptrending, red for downtrending.
- Environment Section:
- ma20, ma50, ma200: green for above the average, red for below the average.
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