Tuesday, June 19, 2012

ADM: Swing play (updated)

Archer Daniels Midland Co. (ADM) a few years back promoted its business with the slogan "Supermarket to the World". That's not far off the mark. If its edible, then you can be fairly certain that the Decatur, Illinois company's 30,000 employees and 265 processing plants have a hand in it as part of ADM's global operations.

Our interest, however, is less in ADM's corn, cocoa and soy, and more in the chart. For ADM is one of the very few top-volume stocks in the Russell 1000 to be a) underpriced, and b) not gapping downward in free-fall as I run the charts today.

Despite all of the euro-angst and fiscal-cliff fears, the markets are all in all trading above the lower ranges of their historical levels, whether viewed for a week, or a month, or a year.

That's not to say that ADM hasn't dropped. The open this morning saw the price plummet from $31.39 down to $30.38, a 3% loss in just three hours.

The decline carried the price down to the low area of a sideways range that has been in effect since March. The level is a bit raggedy but $30.40 is close to the floor.

If it reverses, it has no serious daily-chart resistance until it hits $32.70, the most recent level of the range ceiling, for a 7% gain.

In other words, ADM at this point is a classic swing play -- buy at the floor and sell at the ceiling. Another approach would be to use a sideways strategy, such as an iron condor or a double diagonal spread, to lock in profits as long as it stays within the range -- call it $30 to $33.

I like it better as a directional play because the price is at the low end of the range. Were it at mid range, I would go for the iron condor.

I consider ADM to be underpriced because in the last 20 days of trading the greatest number of trades has occurred at $31.92.

One standard deviation from that level, containing 68.2% of trades, gives a fair-price range of $31.28 to $32.59. Now $30.41, ADM is at a level less likely to attract sellers.

ADM's trading pattern is complex, however. There are two other price/volume outliers, one at $31.26 and a second, smaller one at $30.77. Either could become a new sticking point if ADM should reverse and climb.

And it has begun to reverse, with prices rising within two half hours, with both setting higher highs. (I'm writing at about 1:30 p.m. Eastern)

Looking at today's trading only, the highest volume price is $30.70, with a fair price range between $30.29 and $30.86. So even within day-trader territory, ADM is priced below the most sought-after price.

Archer Daniels Midland has return on equity of 8%, making it a slow and steady performer, with debt higher than I like, at 56% of equity. Institutions own 71% of shares and the price is quite cheap -- it takes only 23 cents to control a dollar in sales.

Earnings for the most recent quarter were up sharply from the prior quarter, but all in all, the trend of earnings has been down from 2011 into 2012. The company has been profitable the last 12 quarters, with an earnings surprise in each. Four of the surprises have been negative.

On average, ADM trades 4.7 million shares a day, which supports a sufficient selection of options strike prices with narrow bid/ask spreads.

Implied volatility is 24%, in the lower half of the six-month range. Options traders are pricing in confidence that 68.2% of trades will lie between $28.38 and $32.70 over the next month.

Both puts and calls are trading around 70% above their 5-day average volume.

Archer Daniels Midland next publishes earnings on July 31. The stock goes ex-dividend in August for a quarterly payout yielding 2.29% annualized.

Decision for my account: I like ADM as a swing play, taking the bullish leg at this point. I've bought call options with December expiration and a $28 strike. I got the order filled with the stock priced at $30.53 and  will set the initial stop loss at $30.28, which is one cent below the fair price range in today's trading. If the rise continues -- if I have a viable position -- then I'll move the stop daily to lock in interim profits.

Update: The stop/loss got taken out an hour after the position was opened, for a loss of $23 per contract. Bad play! Me and Jamie Dimon.

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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