Tuesday, October 2, 2012

CBS: Confirming the signal

CBS Corp. (CBS) broke below its 20-day low today, triggering a Turtle Trading bear signal and also providing an opportunity to test the confirming indicators I wrote about on Oct. 1.

The breakout level is $35.31, and it was reached via a seven-day decline from an all-time high of $38.32 reached on Sept. 21. It was the first test of the $35.31 level since it was set on Sept. 5.

Under classic Turtle rules, I would take the trade without question, ignoring the fact that the price pulled back above the breakout level in the next half hour after the breakout.

The push to a new high in late September seems anomalous on the chart. CBS has been prone over the last six months to long bouts of sideways movement, most recently from early August into late September. The new high was a very brief event, and by the second trading day after it was set, the price had pulled back into the sideways range, where it remains today, toying fitfully with the breakout level.

Whatever the Turtle signals says, traditional support-and-resistance analysis tells me that this is not yet a directional trade, and won't be until the stock sets a lower low. That would mean a decline below $30.52, set July 23, which served as the take-off point up to the present sideways trend and all-time high.

The purpose of confirming indicators is to reduce the number of failed trades that are endemic to the Turtle Trading strategy.

Many of the leading technical indicators seem to always confirm Turtle breakouts, and indeed to lead them. The parabolic sar, Person's Pivot Study, the RSI and MACD, on-balance volume -- all confirm the bear phase.

Two indicators that I've looked at appear to be more likely to give non-confirmation.

The volume-based force index (discussed in the Oct. 1 essay) was rising at the time of the breakout, and therefore failed to confirm it. The confirmation occurred at all spans, from 13-bar down to one, on a daily chart.

To lower the latency, I also tested it on a half hour chart, at 13 bars. There are 13 half hours in the normal market trading day (excluding the thinly-traded pre- and post-market sessions). The price fell below the breakout level in the first half-hour of trading, confirmed by a falling force index, but in the next half hour, as the price retraced, the force index also began to rise, eliminating the confirmation.

The lesson of the half-hour chart, low-latency method may be to go have a cup of coffee or two before coming back to check the force index for confirmation. Like all indicators, after all, it is reactive -- a trailing indicator.

Interestingly, as I reduced the number of bars in the force index on the half-hour chart, the confirmation weakened and at four bars became a non-confirmation, and stayed non-confirming all the way down to one bar.

The four-bar force index turned down, confirming the signal, when CBS moved below the breakout level for a second time, in the fifth half hour of trading. (On the basis of that confirmation, I opened a bear position.)

A second indicator, which I've been using for several months in my analyses, aggregates transactions (not volume) by price. It is called the TPO Profile -- here's a description from my trading platform, ThinkOrSwim.

(This indicator appears in earlier analysis in the section about the fair-price zone.)

I use a today-chart (from the opening of the current trading day). The price with the most transactions is called the point of control, My theory is that if the point of control is beyond the breakout level (below for a bear breakout, or above for a bull breakout), then that is strong confirmation.

In the case of CBS, the point  of control is at $35.47, above the breakout level.

The TPO Profile also uses upper and lower lines that encompass 68.2% (one standard deviation) of trades. If the current price is below the lower line, that is also a confirmation of downside momentum, although a weaker one that the point of control placement.

The upper line is at $35.59 and the lower at $35.28.

CBS moved below the lower line in the fifth half hour of trading, concurrently with the second fall below the Turtle breakout level.

All of this adds a lot of complexity to the Turtle strategy. It is so much easier to simply automatically take the trade and set the stop/loss. Is it worth it? Time and trading results will tell. CBS will serve as a test case, and there will be others.

(As I was writing this, SBUX broke out to the downside, confirmed by both the daily and half-hour force indexes, but not by the TPO Profile point of control. I opened a bear position. AAPL also had a Turtle bear signal, but it was unconfirmed by the force index at all levels and the point of control. I've not acted on AAPL and probably won't take the trade, since I'm already exposed through diagonal option spreads.)

This has been too much fun, but I guess due diligence suggests I should go through the rest of the analytical drill for CBS.

Analysts are quite happy with CBS, showing a 29% enthusiasm index.

The company is diverse, but very much centered on entertainment, which provides more than half of its earnings. (Other segments include cable networks, publishing and local broadcasting.)

CBS is not a growth stock. Return on equity is 15%. Long-term debt is higher than I like to see, at 58% of equity.

True, the earnings have recovered quite nicely from their deep 2008 recession loss. The top-earning quarter, the 2nd, reported in August, rose in 2011 and 2012 compared to the year-ago quarter. (Note that the 2010 Q2 was on eof the two lowest earners.)

Ten of the last 11 quarters have shown upside earnings surprises; one was no surprise.

Institutions own 81% of shares, and the price has been bid up to slightly above par. It takes $1.56 in shares to control a dollar in sales.

CBS on average trades 8.6 million shares a day, sufficient to support a wide selection of option strike prices. Open interest runs to the three- and four-figure range near-the-money in the front month. The front-month at-the-money puts have a bid/ask spread of 8%.

Implied volatility stands at 29%, slightly below the six-month mid-point. It has been on the rise since late September.

Options are pricing in confidence that 68.2% of trades will fall between $32.17 and $38.13 over the next month.

The option volume is on the lackadaisical side, running at 56% of its five-day averge. Puts lead at 90% of the average, compared to calls at 47%.

CBS next publishes earning son Nov. 7. The stock goes ex-dividend in December for a quarterly payout yielding 1.37% annualized.

Decision for my account: As noted above, I took the trade after it was confirmed by another indicator. I structured the position as January puts with strikes of $38, for 6x leverage. The initial stop/loss is above $36.66.

Based on support and resistance, I probably would not take the trade today, waiting instead for another day or two of decline.

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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