Tuesday, July 24, 2012

WFC: The breakout point.

As Europe continues to pass through the Seven Stages of Greece and the Pain in Spain, Wells Fargo Co. (WFC) has one big strike against it: It's a bank.

Banks are exposed to all the craziness that the euro-zone is capable of. So banks make traders like me very, very nervous. Long story short: I understand liquid markets and can hedge them. I don't understand nervous politicians and find them to be unhedgable.

As  banks go, San Francisco's Wells Fargo is not in the top ranks. True, it's listed as the 4th largest bank in the U.S. by assets, and the largest by market capitalization. But it only ranks 24th globally by assets, just above Credit Suisse.

Wells Fargo has European exposure. But there's no reason to believe that they're at greater risk than any other large bank. It's not the individual company that's the problem. It's the sector.

On the daily chart, WFC has been in an uptrend since June 6, a rise that carried it from $29.95 to a July 16 high of $34.35. Since then it has worked sideways for four days, and then gapped down to the present two-day range, running from $33.10 to $33.71.

The downside gap came renewed euro-angst. The priced rose sharply on July 13 after WFC announced earnings that were close to expectations.

The key take-away from this chart is the uptrend. The earnings bounce pushed the price to a higher high within the present swing. The gap down still kept a higher low in place. It's the sort of set up that a bargain-seeking trader will declare to be an opportunity to buy low in order to catch the next step up in the trend.

Longer term, WFC has been in a sideways trend since the spring of 2009, bouncing between about $23 and $34. A decisive break above the March 19 high of $34.59 would spell the end of the sidewinder.

That breakout point -- $34.59 -- is crucial to the logic of any WFC position.

The cautious trader will wait for the breakout before entering WFC. The risk-taker will see the present very minor pullback as a chance to get in before the upward thrust. And the story trader will be paralyzed with fear lest Spain default, destroying the euro and the global economy as we know it.

Analysts, actually, are quite enthusiastic about WFC, with an enthusiasm index of 56%. That's up from 54% a month ago, due to one analyst adding coverage at the strong-buy level.

Wells Fargo reports return on equity of 12% with the usual somewhat high level of long-term debt that is common to banking. Debt is running at 122% of equity.

Annual earnings have risen continually since hitting a recession low in 2008. Quarterly earnings have also seen a continual rise from 2010 onward. All of the last 12 quarters have shown positive earnings, and 10 have shown upside earnings surprises, with two surprising to the downside.

Institutions own 76% of shares, and the price has been bid up considerably. It takes $2.14 in shares to control a dollar in sales.

WFC on average trades 26.8 million shares a day, enough to support a good selection of option strike prices with very high open interest and very narrow bid/ask spreads.

Implied volatility stands at 25%, near the floor of its six-month range. It has been trending sideways since mid-July. Optoins are pricing in confidence that 68.2% of trades will fall between $30.93 and $35.67 during the next month, for a potential gain or loss of 7%.

Options are trading only slightly above their five-day average volume, but with a huge difference between calls and puts. Call volume is running at about half the five-day average; put volume, at about double.

The stock is trading within today's fair-price zone, which runs from $33.19 to $33.42 and encompasses 68.2% of trades surrounding the most-traded price, $33.31. The five-day fair price zone runs from $33.48 to $34.32, and because of the recent downside gap the stock is trading below the five-day zone.

Wells Fargo next publishes earnings on Oct. 15. The stock goes ex-dividend in August (probably early August) for a quarterly payout yielding 2.64% annualized.

Decision for my account: I'm inclined to wait for a breakout from the sideways trend, above $34.59. One reason for waiting is the ex-dividend date, which will probably come within the August options period and so will increase the chances of any WFC options I sell being assigned early. Plus, it's a bank. The euro-zone crisis with Greece and Spain is a real wild-card that I don't know how to play.

For those reasons, I'm passing on the trade.

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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