And down goes the stock -- I mean, ship -- with much loss and sorrow, with chunks of earnings -- I mean, ice -- floating in its wake.
The apparel-maker V.F. Corp. (VFC) is a case in point. It has been in an uptrend since July 3 from a low of $129.53, and the swing carried it to an all-time high on Oct. 17 of $169.82.
The stock broke above its 20-day high on July 19, entering bull phase under the Turtle Trading rules, and continued in-phase until Sept. 28, when it dipped below the 10-day low, forcing a sale of long positions.
That proved to be a head fake, and it again broke above the 20-day high back into bull phase on Oct. 15.
It faltered a bit in the two ensuing days after its all-time high, and then came this morning's earnings announcement before the open.
The company beat analysts' earnings estimates, but fell short in revenues. The price gapped down and pierced the 20-day low level for the stock, triggering a Turtle bear signal.
My interest in VFC is to study how my trading rules (you can read them here) would apply to this complex, earnings-driven chart.
Although my rules are based on those of the Turtle traders, I've added some exceptions to account for earnings. The original Turtle Trading rules were applied mainly to futures markets, which don't have anything like the quarterly earnings announcements that impact stocks.
I have two rules that will dominate my discussion:
For entry, I don't open new positions in the 30 days prior to publication of earnings. That gives me time to take advantage of the position building that big players do in anticipation of earnings.
For exit, I also have some rules that apply specifically to breakouts immediately after earnings are announced.
I use two terms in this connection.
Earnings Day is the first trading session after earnings are announced. In the case of VFC, that would be today -- Monday -- becomes earnings were published before the open.
Reset Day is the trading session after Earnings Day. The terminology comes from the idea that earnings each quarter provide a reboot of traders' expectations about a company and its stock.
My rule is not to trade a breakout on Earnings Day, and to consider the 20-day high or low on Reset Day to be the breakout level.
Here's how the rules play out on the VFC chart. (That's theoretically. I didn't make these trades in my accounts.) This scenario assumes that I ignore the 30-day rule that would preclude trades so close to earnings.
Oct. 15 - Price pierces the 55-day high (including the 20-day) of $164.35, confirmed by another indicator, the relative strength index (RSI). But the signal fails on the 30-minute rule, since the price retraced to below the breakout level within 10 minutes. No trade.
Oct. 16 -- The price again pierces the breakout level and persists, allowing the opening of a bull position with an entry of about $166.32. The RSI moves into overbought territory.
Oct. 19 -- The RSI exits overbought territory. This triggers an immediately close of the position, probably at about $167, for a very small profit.
Oct 22 -- Earnings. Gap below the 20-day low of $156.87. I don't even consider taking the trade because it is Earnings Day. (Even if it wasn't, the price remained below the breakout level for only 10 minutes, so the trade would have been disallowed in either case.) Today's low (so far) is $154.46, and that's the new 20-day low.
Oct. 23 -- I can consider opening a bear position on Tuesday if the price is below $154.46 at some point in the day, subject the delay and confirmation restrictions outlined in my trading rules.
So the score is:
- My rules: Exit $167.00 minus Entry 166.32 equals a 0.4% profit.
- Original Turtle rules: Exit $159.31 minus Entry $164.35 equals a 3.1% loss.
I'll be keeping an eye on the comparables between the two methods to see how they work more broadly. But I find the VFC chart to be encouraging.
Of course, my 30-day exclusionary rules means that I wouldn't have taken the Oct. 16 bull signal, six days before earnings were scheduled to be published.
Both by my rules and the Turtle Trading rules, the July 19 breakout to the upside would have triggered us to open positions, probably at about $145.70. We would have sold on Sept. 28, when the price fell below the 10-day low, perhaps at about $158. So we both would have made an 8.4% profit.
The difference is, under my 30-day rule I would have kept all of that profit but would have missed out on a 0.4% gain. The Turtles would have lost a portion of their profit, bringing the net down to 5.3%.
The unanswered question is: What to do with existing positions as earnings approach: Sell before publication? Wait for the announcement? I don't have an answer to that yet.
My current practice is to not exit before earnings, absent another signal, such as an RSI cross from overbought or oversold into the middle ground.
Charts aside, there's the question of whether VFC is worth trading or not. It's a big company with a broad reach. Headquartered in Greensboro, N.C., it makes a number of brand names sold in other company's stores: Lee, Rustler, Wrangler, Nautica, The North Face -- these are household names even in households that never heard of V.F. Corp.
Analysts liked the company a lot going into earnings with an enthusiasm index of 32%, up from 28% two months ago.
Going into earnings, return on equity was 21% -- growth stock territory -- with not-bad long-term debt amounting to 40% of equity.
Annual earnings per share rose sharply in 2010 and 2011 from the recession low. Quarterly earnings tend to peak in the 3rd quarter, when stores are stocking up for the Christmas season. Q3 of 2011 was up from the corresponding quarter in 2010.
Of the past 11 quarters, all have been profitable and all have shown upside earnings surprises.
Institutions own 84% of shares -- a high level -- and the price has been bid up a bit: It takes $1.77 in shares to control a dollar in sales.
Overall, my fundamental bias on V.F. Corp. would be bullish, and I would be reluctant to take bearish positions whatever the signals.
VFC on average trades 482,000 shares a day, putting it below my normal liquidity rules -- I prefer 3 million shares a day or greater. Even so, the stock supports a good selection of option strike prices with mainly three-figure open interest near the money.
The front-month at-the-money bid/ask spread on puts is 12% -- a bit high but surprisingly low for a stock trading under 500,000 shares on average.
Implied volatility stands at 2%, having taken a huge drop with today's downside gap. It stands in the lower half of the six-month range and, before today, was in the midst of a month-long climb.
Options are pricing in confidence that 68.2% of trades will fall between $146.79 and $169.99 in the next month, for a potential gain or loss of 7%, and between $152.82 and $163.96 over the next week, for a gain or loss of 4%.
Options are running well above their five-day volumes: 221% above overall, with calls leading at 259% above volume, compared to 196% above for puts.
The fair-price zone on today's half-hour chart ranges from $159.17 to $162.18, encompassing 68.2% of transactions surrounding the most-traded price, $159.75. With two hours before the close, the stock is trading below the range.
V.F. Corp. next publishes earnings sometime in January. It goes ex-dividend in December for a quarterly payout now yielding 1.82% annualized.
Decision for my account: It's no trade today under my rules, for the reasons outlined above. And even if VFC were to break below its 20-day low on Tuesday, triggering a bear signal, and even if liquidity weren't an issue, I probably still wouldn't take the trade. The fundamentals are so strongly biased to the upside that I don't want to trade counter to them.
Disclaimer
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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