Tuesday, September 25, 2012

COH: Bearish breakout, bullish financials

The bags and accessories company Coach Inc. (COH) broke below its 20-day low today, triggering a Turtle Trading bear signal. Under Turtle rules (you can read about them here), that's a mandatory new position, as long as it fits into my plan's diversification rules.

It's a bearish breakout, but -- spoiler alert -- the company has great financials. This is known as the Trader's Dilemma. Who do you believe? The accountants or the charts?

The price peaked in the prior swing up at $63.24 on Sept. 10, a price that broke through the 55-day high, triggering a Turtle bull phase that turned out to be a failure.

The rise that led to the the Sept. 10 peak began on Aug. 2, the day a low of $48.24 was set. That is the 55-day low, which in Turtle-land produces an even stronger signal than a 20-day breakout.

Almost always in breakout trading, the question is whether the breakout is the peak of a sideways movement, or an instance of directional momentum. The way a trader finds out, in the Turtle system, is by taking a the trade, setting a stop/loss, and seeing if the position makes money.

The August low was set as a result of a gigantic gap triggered  an earnings announcement that surprised to the upside but contained other information that spooked traders.

The current breakout is near the downside support level for the latter half of August, a level that was more of the meandering random variety rather than one that survived repeated tests. I don't consider it to be a strong support level.

The 55-day low is a strong level, one that was also tested in 2011. So that suggests downside potential to around $48. Below that, the future remains to be seen.

Long term, a drop below $46 would set a lower low, removing ambiguity from the retracement of the rise form the recession low of 2009 to the all-time high of $79.70 set in March.

Coach is an older company -- founded in 1941 -- that defines itself by classic styles and quality crafting. Its product line includes handbags, shoes, watches, sunglasses, jewelry, briefcases, belts -- The company started out as leather-crafters, but has branced out since.

Coach operates more than 500 stores in the U.S. and Canada, and more than 300 in East Asia. It's distribution network also reaches into Europe and Latin America, as well as other Asian regions.

Analysts are positive on the company, with a 30% enthusiasm index, although that has dropped from 39% a week ago.

Annual earnings have risen steadily from their recession low and in 2011 stood 85% above the nadir.

The Christmas season's 4th calendar quarter (Q2 in the company's fiscal year) is the earnings peak, and that quarter's earnings have risen the past two years. All of the past 11 quarters have produced upside earnings surprises.

So, based on earnings alone, this is not a downtrodden company facing big trouble, but rather a money-maker going through a rough patch on Wall Street.

I mean, return on equity is 55% (!!). Long-term debt is zero (No debt!!). It's almost an embearrassment to open a bear position on this stock.

But, the signals are as they are. Clearly the market is anticipating rough times ahead. As a trend follower, my strategy is to jump on for part of the ride.

Institutions are certainly on board, although no doubt on the bull side. They own 90% of the shares, and the price is relatively high. It takes $3.33 in shares to control a dollar in sales.

COH on average trades 4.9 million shares a day. It has a wide selection of optoins with open-interest running in the three- and four-digits near the money. The bid/ask spread for at-the-money front-month puts is 3%, a fairly low level.

Implied volatility stands at 37%, just below the mid-point of the six-month range. It has been stair-stepping up  since mid-September.

Options are pricing in confidence that 68.2% of trades will fall between $48.905 and $60.57, for a potential gain or loss of 11%. This is more volatile than most of the stocks I've written up of late.

Options are trading actively, at 61% above their five-day average volume. Puts lead at 73% above the average, compared to 36% for calls.

The fair-price zone, with a bit less than two hours of trading left, runs from $54.99 to $55.59, encompassing 68.2% of transactions surrounding the most-traded price, $55.20. The current price is a bit below the zone.

Coach next publishes earnings on Oct. 22. The stock goes ex-dividend in December for a quarterly payout yielding 2.19% annualized.

Decision for my account: I took the trade under Turtle rules, and did so with very few reservations, for the reasons given in my discussion of support levels earlier in this essay. I structured the trade as a January put with a strike price of $60, for 5x leverage. The initial stop loss will be double the 20-day average true range, placing it above $58.90 on the basis of my entry at $55.20.

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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