Thursday, January 13, 2011

VAR Watch

Varian Medical Systems Inc. (VAR), which designs and manufactures medical gear for treating cancer, moved to bull phase today in advance of its earnings announcement after the close on Jan. 26. The phase change was confirmed by a sharp rise in the polarized fractal efficiency line.

ppspfe trendpfe loc

VAR has shown a tendency for positive earnings surprises with price increases to match, although not during the depths of the downturn. Only the most recent quarter's earnings showed an upside surprise. The prior three were downside surprises, and the one before that was on the mark.

So we're having to stretch back to those happy days before the collapse of capitalist finance to make the case for VAR as an earnings play.

If a company deserves to be prone to happy surprises, it is VAR. It has a 28.4% return on equity and no debt to speak of. Return on equity has risen in each of the last five years, as have revenues and earnings per share.

Revenues and earnings are forecast to increase again this year.

The stock pays no dividend -- and that's a good thing if you believe Warren Buffet (see my Buffet remarks in today's posting on MVO).

Institutional ownership is a full 91%, which means major moves will most likely be the work of the pros rather than panicky amateurs.

True, it's a tad overpriced, with a price/earnings growth ratio of 1.29%. I can live with that.

VAR hit an all-time high on Dec. 21, moved to a swing low on Jan. 10 and has risen off of that level for three days straight. It is trading right at the 20-day moving average, and well above 50-day and 200-day moving averages.

Reversal Levels
  • $70.97, +1.6% (all-time high)
  • $69.88 --- You are here.
  • $69.80, -0.1% (20-day moving average)
  • $67.42, -3.5% (swing low)

The long-term prospects are good but with a hint of caution. The problem is the confirmation line, which is moving pretty much sideways right along the +50 level. I would be happier if it were rising or trading with a greater margin above +50.

However, it is, technically, in confirmed bull phase according to my slow-trading rules.

Monthly chart
ppspfe trendpfe loc

I like VAR for my own account as an earnings play, although the options inventory is not perfect for the way I like to structure these positions.

The strike prices are $5 apart. Moreover, the stock is trading just below the $70 strike, whereas support is down toward the $65 mark (actually, it's at about $67).

One possible vertical, a bull put spread, would be to sell the $65 puts and buy the $60 (February expiration on both legs), for a credit of $45 per contract.

But that produces 1:10 reward/risk ratio -- for every $1 I can potentially make, and risk losing $10. No thanks!

An alternative is to sell the $70 and buy the $65, for a $142 credit per contract. The reward/risk ratio is far more attractive, at 1:2.5. But $70 is at the money, so a price decline will turn this into a losing position far quick that would be the case with the riskier $65/$60 vertical.

I chose the $70/$65 vertical, and was able to fill it for a credit of $136 per contract.

As a trader, you either trust your analysis or you don't. If it turns out to be wrong, you skedaddle.

  • pps - Person's Proprietary Signal.
  • pfe trend - Trend of the polarized fractal efficiency line.
  • pfe loc - Location of the polarized fractal efficiency line.

Key to the PPS/PFE tables
pps bull phase
bear phase
pfe trend uptrend
no trend
pfe loc +100 and above
+50 to below 100
0 to below +50
below 0 to above -50
-50 to above -100
below -100

PPS/PFE Analytical Tools

The analysis uses the daily Person's Proprietary Signal (pps), developed by John Person.

This is a black box signals -- the "proprietary" means that Mr. Person knows how it works under the hood, and I don't. But it has shown a fair degree of success in identifying good entry and exit points, and I find it useful.

For confirmation, the analysis uses an indicator called the polarized fractal efficiency (pfe) technical tool. It uses the fractal math of Benoit Mandelbrot to measure how efficiently move between levels. The higher the efficiency, the more directional the price trend.

The math for the pfe is public knowledge, but it is well above my math knowledge, and so to me is also a black-box signal.

This is a relatively new technical tool, based on fractal math. Investopedia has only a cursory explanation. Wikipedia is silent on the subject. ThinkOrSwim has a fuller explanation.

PPS/PFE Trading Rules

These rules are very preliminary. I’m still trying to figure out how the polarized fractal efficiency signal works.

When Person’s Proprietary Signal (pps) is in bull phase, enter when the polarized fractal efficiency (pfe) line crosses the zero line in an uptrend trend) A pps signal and pfe uptrend have less strength but greater upside potential when the pfe location (pfe loc) is below +50, and greater strength but less upside potential when the pfe location is at or above +50.

When the pps in in bear phase, enter when the pfe trend crosses the zero line in a downtrend. The set up has less strength but greater downside potential when the pfe loc is above -50, and greater strength but less downside potential when the pfe loc is at or below -50.

How should the pfe line be treated when it has flatlined at either end of its range, around +100 or -100. My preliminary observations are that the price by then has had a large run and tends to present a picture of exhaustion. However, by the description of the pfe, a high level should indicate a continued strong trend.

This is something that I’ll figure out as I go along.

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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