Wednesday, November 28, 2012

Art of the Tentative

This has been a day of tentative breakouts within a week, so far, of nothing much.

I'm following three breakouts today. I say "following" because they keep retreating or pausing just above the breakout level, as confused by the broad new vistas opening up on the far side of the price channel boundary.

My trading rules, based on the well-known Turtle Trading method, handle drama quite well -- breakouts, breakdowns, sturm und drang -- not a problem. But the tentative? That is a different matter indeed.

The three breakouts, all to the bullside, are two stocks, Coach Inc (COH) and Phillips 66 (PSX), and one exchanged-traded fund, EWG, which tracks German stocks.

Up front: I'm not going to trade any of these stocks. In this brief discussion, I'll focus on why none is making the cut.

I ran all three through my triage routine, which attempts to assess the strength of the upward move. It has two parts.

The first: Out of the five trading days preceding the breakout, what percentage had a higher low than the day before (for bull breakouts, or lower high for bear breakouts).

The second: Subtract the closing price the trading day before the breakout with the close on the fifth day prior to the breakout.

Five is a week in market time, so I chose that as the smallest unit above a day that encapsulates a meaningful period in trading.

Then I convert the second number to a multiple of the stock's average daily trading range, and multiply that number by the percentage I got in step one.

The result is the trend score.

COH and PSX has small trend scores, 0.36 for COH and 0.43 for PSX. Part of that was because each had higher lows on only three of the five days preceding the breakout. Also, their price rise (step two) over the five days was less than a singe day's average range.

EWG had quite a respectable score of 2.56, based on each of the five preceding days showing higher lows, and a total rise, close to close for that period of more than two and a half times the average trading range.

However, EWG has an average volume of 2.9 million shares, and while it has four-digit open interest for the front-month at-the-money calls, the open interest shrinks to two-digits $1 out, and one digit $2 out from at-the-money.

That is far to illiquid for my purposes.

So, for those reasons, no trade today.

My point in all of this is that although the Turtle Trading rules, upon which my rule set is based, famously demand that any breakout within the trader's universe of prospects be traded immediately, the reality on the chart and the options grid sometimes dictates prudence and a decision based on factors other than the breakout.

Turtle purists will turn up their Turtle-ish noses in disgust, but as a trader I feel I must above all THINK and not follow the cautionary slogan that used to be posted in IBM offices back when it was the leading computer company in the world: THIMK.

References

My trading rules can be read here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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.

Tuesday, November 27, 2012

FSLR: Sunny side up

First Solar Inc. (FSLR) broke up its high of the last 55 days, creating a bull signal under my trading rules. The price has been trading an ascending triangle since late August.

Volume today was about triple the recent average, a sign of heavy momentum behind the move.

First Solar has been a huge disappointment the past two years for those who trade on stories rather than charts. From a high of $175.45 in February 2011, the price plummeted to a low of $11.43 last June.

It's an oft-told tale: Hop on the Next Big Thing too early, and it breaks your heart.

So I'm not an ethusiast about FSLR because it's clean energy and sunshiny and new tech and all of that. It's a breakout on the chart that met my rules.

The momentum leading up to the breakout was somewhat on the low side, with a trend score of 0.74. I'm more confident with a score of 2.0 or better, but a low score isn't a deal killer.

Very briefly, since we're near today's close:

Analysts hate this stock; the enthusiasm rating is a negative 75%.

Return on equity is 10%, which is respectable, and long-term debt is low, at 14% of equity.

Institutions own 72%, and the price is way cheap. It takes just 75 cents in stock to control a dollar in sales.

I'll skip the options analysis except to say that the selection was sufficiently liquid to meet my needs. Implied volatility is very high at 72%.

First Solar next publishes earnings on Feb. 25.

Decision for my account: I took the trade, structuring the initial position as a bull put options spread, short the $24 put expiring in December and long the $23 put. This puts my break-even point at $22.99, which, thanks to the high volatility, is below my standard stop/loss at $23.58. The potential yield on the position is 31%.

If the price continues to rise, triggering additions, I'll buy long calls expiring in March, with a delta of around 70.


References

My trading rules can be read here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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.

Monday, November 26, 2012

FB: Into the gap

Facebook Inc. (FB) gapped past its high for the past 55 days: $24.68. More important, the rise carried the price into the gap left by the stock's fall on July 27, as it tumbled down to the channel where it has meandered ever since.

The price had in fact first broken past the 55-day high two trading days earlier, but without the strong momentum seen today. So I'm treating today as the breakout point, although that is a bending of the rules.

Facebook has proved to be the premier drama queen of the markets. As it charges into the July gap, the question to ask is whether we're seeing General Patton and his tanks driving into Germany, or Lord Cardigan leading his cavalry in the Charge of the Light Brigade.

When FB gapped last October, I wrote in "FB: A gap, but not quantum leap", about the two orbits that have marked the stock's behavior since the company went public in March. The price remains below the floor of the upper orbit -- $26.73 -- but it is for the first time approaching that level in a break above the lower orbit's ceiling -- $23.37, with a few head-fakes mixed in to keep things interesting.

For the near term, the chart shows a clear uptrend: A low of  $18.80 on Oct. 19, a high of $24.25 on Oct. 24, a higher low of $18.87 on Nov. 12, and now a higher high of $26.05 (so far) today.

The volume is higher than that of the last week, but since it was a holiday week, that fact adds nothing to the analysis.

Facebook -- the company -- needs no explanation. It's one of the great cultural names of our time.

Analysts have grown more positive about the company in the last three months; an index based on their recommendations shows enthusiasm more than tripling, from 7% to 24%.

To a remarkable extent for a company perceived as being an innovative growth prospect, return on equity is quite low, standing at 6%. On the other hand, long-term debt is also low, at a bare 4% of equity.

The company has released only two quarterly earnings since going public, each with identical earnings per share and with virtually no surprise compared to analyst expectations.

Institutional ownership is way low, at 35%. Yet the price is way high; it takes $11.22 in shares to control a dollar in sales.

From a fundamental standpoint, at this stage, FB would be a foolish purchase in my book. If I had a very long term trading horizon, I might stash some shares away in a corner of my portfolio, hoping to cash in big some years down the line.

But my horizon is much shorter, and therefore fundamentals don't count for much in my trading decisions.

FB's strong upside break into the July gap signals to me that there's something's happening here. (What it is ain't exactly clear. For what it's worth.) For my style of trading, the proper course is to jump aboard for awhile and see where the train goes.

For triage, when selecting among trade possibilities, I score the price movement for the past five days.

If it's an upside breakout, I see what percentage of the lows for those days represented a higher low from the prior day. By that measure, FB did outstanding, at 80%.

I also calculate the price difference between the close the day before the breakout, and the close five days earlier, convert it to a proportion of the average true range, and then combine that (by multiplying) with the percentage of higher lows, to produce a trend score that shows very near term momentum before the breakout.

FB's trend score is quite low, at 0.32. (By contrast, my other breakout trade today, MO, scored 3.42.) I will argue that the push into the July gap is of sufficient importance to overshadow the trend score. We shall see if my thinking is correct.

FB on average trades 92.3 million shares a day, making it one of the most liquid individual issues on the market.

It supports a very wide range of option strike prices with open interest near the money running to five figures. The front-month at-the-money bid/ask spread on calls is 3%.

Implied volatility is high compared to other stocks, at 49%, yet it stands near the bottom of the six-month range. Volatility has been rising since Nov. 21.

Options are pricing in confidence that about two thirds of trades will fall between $22.21 and $29.55 over the next month for a potential gain or loss of 14%, and between $24.12 and $27.64 over the next week, for a gain/loss of 7%. The one month gain or loss is seven times the average trading range, and the weekly, four times.

Two hours before the close, the fair-price zone on today's 30-minute chart runs from $25.47 to $26, encompassing about two-third of transactions surrounding the most-traded price, $25.84. The stock is priced at about the most-traded price.

FB next publishes earnings on Jan. 23.

Decision for my account: I opened a bull position, structuring it as a bull put vertical spread, short the $24 December put options and long the $23 December puts, for a $22 credit per contract. The break-even point is $23.80, slightly above a stop/loss at $23.62, which amounts to twice the average daily trading range. The potential yield of the position is 17%.

My rules tell me to hold this spread until it expires. If the price should rise enough to trigger additions to the position, I'll buy March call options with deltas near 70, and apply a trailing stop/loss amounting to twice the average daily trading range.

References

My trading rules can be read here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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.

Sunday, November 25, 2012

The Week Ahead: Durables, Income, Outlays, Savings

Durable goods orders on Tuesday and personal income and outlays on Friday, both at 8:30 a.m. Eastern, bracket the week's economic reports.

Durable goods, which tracks big-ticket items, is a measure of how confident businesses and people are that they can buy expensive stuff and put it to productive use. If durables are doing good, that bodes well for the broad economy.

From income and outlays is derived the personal savings rate, a key measure of our willingness to shop till we drop.

In between, and of lesser significance, look for new home sales on Wednesday at 10 a.m. and the second try, the preliminary, at the 3rd quarter gross domestic product, on Thursday at 8:30 a.m. The GDP is a revision of last month's release and will be low impact unless the first version got the numbers horribly wrong.

Leading indicators out this week (in order of importance):

The interest rate spread between 10-year Treasuries and the federal funds rate, reported continually during market hours.

The M2 money supply, moved to Friday 4:30 p.m. because of the holiday, from the Federal Reserve.

The S&P 500 index, reported continually during market hours.

Average weekly initial jobless claims, at 8:30 a.m. Wednesday, a day earlier than usual because of the holiday.

Other reports of interest:

Monday: The Dallas Federal Reserve manufacturing survey of Texas businesses, 10:30 a.m.

Tuesday: S&P Case-Shiller home price index, the lone housing report that recognizes that all real-estate markets are local, at 9 a.m., ahd the Conference Board's consumer confidence report at 10 .m.

Wednesday: Petroleum inventories at 10:30 a.m. and the Federal Reserve's Beige Book, a report on conditions in each Fed region, at 2 p.m.

Thursday: The Realtors' pending home sales index -- deals signed but not yet closed -- at 10 a.m.

Friday: The Chicago purchasing managers' index, tracking conditions in Chicagoland, at 9:45 a.m.

I also like to keep an eye on the Baltic dry index of world shipping, updated daily.

Fedsters

Federal Reserve Chairman Ben Bernanke gives opening remarks on Tuesday at 8:30 a.m. at the National Fed Challenge, an event for high-school students that teaches them to think like a Fedster. Can this truly be good for youthful minds?

Three members of the Federal Open Market Committee, responsible for setting monetary policy, also take to the podiums: Atlanta Fed Pres. Dennis Lockhart on Tuesday and Cleveland Fed Pres. Santra Pianalto and Fed Gov. Daniel Tarullo on Wednesday, 

Trading calendar

By my rules, as of Monday I can trade December short vertical spreads as well as the short legs of diagonal and calendar spreads, covered calls, iron condors, and butterfly spreads, and March single options and straddles. Of course, shares are good at any time.

Good trading!

Tuesday, November 20, 2012

DLTR: Price rise

Dollar Tree Inc. (DLTR) beat earnings estimates by a 39% last week, kicking off a price rise in the stock that on Tuesday broke past its high point of the past 20 days.

The purveyor of cheapness has been in a downtrend from $58.62 on June 20 and hit a swing low of $37.12 on Nov. 9.

Past that, until the earnings announcement, the price drifted sideways for three days.

The 20-day high breakout was $40.97, a resistance level that was the peak of a brief late-October correction to the upside.

DLTR showed an uptrend for four of the five days leading to the breakout, and the total price rise for those five days was $2.74. To set that number in perspective, it amounts to the distance DLTR's price typically travels in two days plus an additional two hours of trading.

My trend score for those five days is 1.9 -- the price rise adjusted for the persistence of the trend.

The next upside resistance is far away, at $49.57.

Dollar Tree, headquartered in Chesapeake, Virginia, operates 4,400 stores, operating also as Dollar Bills, in the United States and Canada. Everything sells for a dollar.

I find it fascinating to roam the aisles trying to figure out what characteristics allow items to go for so little, concluding in most cases that you get what you pay for. I once bought a watch there that died on my wrist after a day of floating in a sheen of Japanese summer sweat.

Analysts show little love for Dollar Tree -- maybe they bought watches there, too. The enthusiasm index stands at a negative 11% today, compared to a positive 21% two months ago.

Which seems contrarian. Dollar Tree's return on equity is 37%, and it has been at that super high range for at least three quarters. Long-term debt is fairly low, at 16% of equity, and has been typically low for at least three quarters.

So I can't argue that the analysts haven't caught up with the company's current situation. It has been making money for awhile.

Another story that might lend a negative twist to Dollar Tree's futures is the idea that as the economy's recovery strengthens, people will move upscale for Dollar Tree.

Like all retailers, DLTR's earnings peak in the 4th quarter, covering the Christmas shopping season. The 4th qarter of 2011, reported in February of this year, beat the prior 4th quarter significantly. The last 12 quarters have all been profitable and have produced earnings surprises to the upside.

Institutions own 82% of shares but the price is only slightly above par. It takes $1.30 in shares to control a dollar in sales.

DLTR trades 4.9 million shares a day on average. The inventory of option strike prices is fairly thin, with most set at $2.50 intervals. Open interest runs in three and four figures near the money, and the front-month at-the-money bid/ask spread is 5%.

Implied volatility stands at 28%, near the floor of the six-month range. Traders are pricing in confidence that nearly two-thirds of trades will fall between $37.97 and $44.53 over the next month, for a potential gain or loss of 8%, and between $39.68 and $42.82 over the next week, for a gain/loss of 4%.

Trade in call options is quite active today, with volume running 83% above its 5-day average. Puts are lagging at 19% below average.

The stock's fair-price zone runs from $40.69 to $41.36, encompassing nearly two-thirds of transactions surrounding the most-traded price, a range from $41.11 up to $41.18. On the way up the price started a trades spike from $40.76 to $40.81, but moved on upward from there.

Dollar Tree next publishes earnings on Feb. 27.

Decision for my account: I opened a position half an hour after the breakout, structuring it as a bull put spread, short the $40 puts expiring Dec. 21 and long the $37.50 puts, for a credit of $51 per contract.

That sets the break-even point at $39.49, a bit above a stop/loss set at double the average daily trading range.

If the rise continues, prompting to add to the position, I'll buy call options May call options with a delta of around 70.

(My trading calendar says I should buy long options expiring March, but DLTR has no March or April options, hence the unusually long lead time.) 

References

My trading rules can be read here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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.

Monday, November 19, 2012

NWL breaks out, bounces back

I love holiday weeks. The markets are open for some of the days, at least, but they generally proceed at a leisurely pace, leaving time for other projects.

My project this week will be to work up some routines to analyze my historical market data, with an eye to understanding better how to reduce false positives among price-channel breakouts.

Also, I get the impression that the 20-day and 55-day channel boundaries -- the standards for Turtle Trading -- serve more as reversal points than breakout levels for forex. I want to test that out, because currencies have the advantage of having higher leverage than options do, but it's an advantage only if the trade goes in my direction.

There were four breakouts -- all stocks -- in the early trading on Thanksgiving Week Monday. That called for triage.

The four breakouts were PGR to the downside and NWL, SWN and TSO to the upside.

All four passed my half-hour test. The price had not retraced to within the price channel a half hour after the signal was given. And all four had acceptable liquidity. So, no help there.

The fundamentals and brokerage sentiment (I use Zacks for this) were bullish on two of the stocks that broke out to the upside, and neutral on the remaining two. When the fundamentals match the direction of a breakout, I take that to be something that gives some slight bias toward a successful trade.

My final step was to judge the trend, in two ways, both looking at the five days of trading prior to the breakout.

First, I wanted to know what percent of those five days trended in the direction of the breakout. To  draw a trendline for a rising trend, my practice is to connect the daily lows. This marks price support for the trend direction. A falling trendline is the opposite -- I connect the highs, providing a line that marks resistance against a further rise.

NWL led the pack with for out of five days showing higher lows, which I scored as 80%. The others came in a 20% and 40%.

My second test is to test the close on the day before the breakout against the close five days earlier. This not only shows whether or not the price over that period is moving in the direction of the breakout, it also shows the magnitude of the move.

I express the move in terms of the 20-day average true trading range, which puts all the stocks in the triage on a level playing field. In Turtle Trading, and in my trading plan, the 200-day ATR is abbreviated as N.

So I code the result as Nx2.2, for example, meaning that the movement in those five days was a bit more than twice the average true range in the direction of the trade. Nx-2.2 would mean, opposite the direction of the trade.

NWL came in best, which a score of Nx1.2. SWN was second, with a miserable Nx0.01. PGR and TSO both moved contrary to the direction of the breakout.

So NWL it is. I've gone into such detail on the triage and the scoring because they'll be part of the  analysis I hope to develop as part of my programming project this week.  My hypothesis is that higher scores suggest stronger momentum at the time of the breakout.

We shall see.

Newell Rubbermaid Inc. (NWL) broke above high price of the past 55 days, $21.33, and pushed to a swing high of $21.52. It remained above the breakout point for the first 2-1/2 hours of trading, but it bounced back below breakout about the time I started to write this piece and after I had opened a position. Not a promising start.

But the Atlanta, Georgia company makes a lot of rubber products. So perhaps a bounce was inevitable. It's products are ubiquitous across a wide range of uses, such as the bookshelves in my basement.

The stock began a mid-term rise on Aug. 31 from $16.87  and has been in a weak correction since mid-October. I say weak because even though correcting, the price managed a slight upward tilt.

The breakout level was a true resistance point, which also adds weight toward taking a trade.

Analysts are optimistic about NWL's prospects, having given it a 55% enthusiasm index for at least the past three months.

And with good reason. Return on equity is 25%, and long-term debt, although higher than I like, amounts to two-third of equity, not a crippling level by any means.

Earnings tend to peak in spring and summer -- the 2nd and 3rds quarters -- and 2012s quarters are about the same as those a year earlier. That sort of pattern marks a mature market in my eyes. NWL is a money maker, but its earnings aren't accelerating.

Institutions own 87% of shares, and the price is about at part: It takes $1.02 in shares to control a dollar in sales.

NWL on average trades 3.9 million shares a day an supports a moderately good selectoin of optoins strike prices with open interest running in three and four figures.

The bid/ask spread on front-month at-the-money calls is quite wide, at 27%, and implied volatility isn't especially high, standing at 21% at the bottom of the six-month range.

Options traders are pricing in confidence that about two thirds of trades over the next month will fall between $19.94 and $22.53, for a potential gain or loss of 6%, and between $20.61 and $21.86 over the next week, for a gain or loss of 3%.

Options trading is slow today -- it is a holiday week -- with calls at 45% of their five-day average volume, and puts at 75%.

The fair-price zone on today's 30-minute chart ranges from $21.22 to $21.46, encompassing about two-thirds of transactions surrounding the most-traded price, $21.35.

One thing I look for in this analysis is whether other prices are gaining on the most-traded. NWL has a second peak in the making around $21.26 or so, the action where the trading is presently occurring. That suggests that the breakout momentum is dissipating and that the trade has a greater chance of failing.

Decision for my account: I took the trade earlier in the morning, back when it looked better. As is my common practice these days, I hedged it, structuring the position as a bull put spread, short the December $21 put and long the December $19 put.

The $37 net credit for each contract means that the position will be profitable at expiration on Dec. 21 if the stock is as low as $20.63, a bit above a $20.48 stop/loss set at double the average true range.

For bullish vertical spreads like this, my rules dictate that I hang on to the position until either the price breaks breaks beyond the 20-day low price, or the relative strength index rises above 70 and then falls back below that level.

References

My trading rules can be read here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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.

Sunday, November 18, 2012

The Week Ahead: Housing and Thanksgiving

Thursday is a public holiday, Thanksgiving Day, in the United States. Markets will be closed that day so traders can enjoy roast turkey and other traditional foods of the day with their families, and will also shut down three hours early on Friday. The other leading money centers will be open for business, including forex trading. (Friday is a holiday in Japan: Labor Thanksgiving Day.)

The week's major econ reports focus on housing, with existing home sales out Monday at 10 a.m. Eastern and housing starts released Tuesday at 8:30 a.m. A third housing report, of less impact, will also be released on Monday: The Home Builders' housing market index, at 10 a.m.

Leading indicators out this week (in order of importance):

The interest rate spread between 10-year Treasuries and the federal funds rate, reported continually during market hours.

The M2 money supply, moved to Friday 4:30 p.m. because of the holiday, from the Federal Reserve.

The S&P 500 index, reported continually during market hours.

Average weekly initial jobless claims, at 8:30 a.m. Wednesday, a day earlier than usual because of the holiday.

Building permits is part of the housing starts report, Tuesday at 8:30 a.m.

The University of Michigan/Reuters consumer sentiment report, Wednesday at 9:55 a.m.

Not itself a leading indicator, the index of leading indicators, a compilation of the forward-looking economic datastreams, will be out Wednesday at 10 a.m.

Other reports of interest:

Wednesday: Petroleum inventories at 11 a.m.

I also like to keep an eye on the Baltic dry index of world shipping, updated daily.

Trading calendar

By my rules, as of Monday I can trade December vertical spreads and March single options and straddles. Of course, shares are good at any time.

Happy Thanksgiving, and good trading!

Friday, November 16, 2012

Zombie Attack!

The market has stabilized on Friday (so far -- knock on wood) ending a week that overwhelmed my trading operation with bear signals.

I'm always suspicious of signals that come during a general market rout. I find price movements that are specific to an individual stock, or perhaps a sector, are more reliable than those that are part of a general rush to the exits.

The week was useful in uncovering a problem with my current practice for initial positions.

Beginning last month, I began hedging the first unit of each trade in an attempt to mitigate the damage from false positives -- breakouts that soon reverse their direction rather than charging onward to glory and profit.

My description of and rationale for the new practice, which allows for the opening position to be a vertical spread rather than shares or simple long options, can be found here.  

The problem is this: At what point should a trader close a vertical spread if the stock moves opposite the spread's profitable direction?

The philosophy behind a spread is quite different from that underlying a simple directional play involving shares or long options, which have unlimited potential in the direction of the trade, and unlimited loss down to zero going the other way.

Spreads, by contrast, have both limited and defined maximums for profit and loss. When I open a spread, I know what the best and worst outcomes can be, and I have the ability to structure both so that the level joy and pain are acceptable.

The trade-off is that spreads by their nature are much less dynamic than simple directional positions. Spreads benefit from the passage of time when they're profitable, so there is a bias against closing the spread. They tend to be buy-and-hold for the month or so of their lives. However, a vertical spread that is unprofitable loses from the passage of time.

Simple shares and options need to be sold at a reasonable stop/loss level to avoid the potential for catastrophic disasters.

But what happens when a stock not only withdraws from a breakout but gives a signal in the opposite direction? What happens to a bullish vertical spread that's still hanging around when the stock gives a bear signal?

I encountered that situation with Discover Financial Services (DFS). It gave a bull signal on Nov. 1, beaking above the 20-day high of $40.86, and I opened a bull put vertical spread for a credit of $25 per contract, with a break-even at the price of $39.75 and a maximum loss at $38.99.

The price fell below the break-out level two days after I opened the position, and on Nov. 15, the price gave a bear signal by falling below the 20-day low of  $37.90.

The spread expires Dec. 21. If I close now, I will take a loss but it will be less than the maximum.

My choices:

  1. Hold the bullish spread in anticipation of a reversal
  2. Sell the bullish spread
  3. Sell the short leg of the bullish spread, retaining the long put to profit from the bearish breakout.
Choice #1 leaves me with a zombie position, a loser just waiting for expiration to put it out of its misery. In addition, if I take advantage of the downside breakout, the zombie will act as a drain on any profits.

I've have had zombies that lived a long time in my accounts, generally because I made a bad trading decision, wasn't nimble enough to get out, and was reluctant to face up to my loss.

Zombies are the children of love. Any trader who falls in love with a stock and a direction is certain to end up with a zombie at some point.

My position in Facebook (FB) was a zombie for a long while, until its decline reversed and I got out  with a loss, but with a smaller one that I would have faced earlier.

I still hold a zombie Fannie Mae (FNMA) position, drooling and lurching through my portfolio as a bad memory of a brief flirtation with penny-stock prices.

Zombies are to be avoided.

Choice #3 has a problem with time. In the case of DFS, the long put expires in December and is losing $2 a day on each contract, a rate that will continue to accelerate until expiration.

Also, simply retaining that one put would muddy the clarity of my rule-based strategy. An initial position is supposed to be a long option expiration in four months or so, or a vertical spread. A long option expiring a month from now is neither.

The rules I'm operating with have enough complexity that I don't need to add to it by trying to bring a zombie back to life.

So my decision is to go with choice #2 -- sell the spread -- and the question is when.

The classic Turtle Trading rules have two stop/losses. Initially, the stop/loss on an opening position is set at twice the average daily trading range  below the entry price. In the case of DFS, at the time of the signal the average range was 79 cents, and so the stop loss was set at $1.58 below the entry level. 

I set up the vertical so that the stop/loss was the break-even point, so selling there would be little or not loss on the position.

However, one goal of using verticals is to avoid whiplash exits but allowing the stock more time to roam. 

In Turtle Trading, once stop/loss level has fallen below the 10-day extreme price in the direction of the trade, then that 10-day level becomes the point at which a trade should be closed.

In my daily chart analysis, that 10-day extreme marks the end of a bull phase or bear phase, meaning I'll set alerts for new breakouts.

A third possibility would be to wait until a 20-day breakout in the opposite direction, and then sell the vertical and enter into a new position if it meets the tests contained in my trading rules.

At this point, I've decided to use the 20-day breakout in the opposite direction. That way, I give maximum leeway for the stock to fluctuate, while avoiding a zombie position acting as a counterweight to an opposite trade.

In the case of DFS, the $39.19 bearside breakout on Thursday is above the maximum loss point, and closing there now cuts my potential loss in half.

I've updated my practice in the Exits section of my trading rules to include this change.


Some reading:
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.

Wednesday, November 14, 2012

XLI: Industrial breakdown

This has been one of those tantalizing days where stocks break below their 20-day price lows, sending a bear signal, but then almost immediately retreat back above the breakout point.

I would have 10 failing positions on my hands if I followed the classic Turtle Trading rule which says, Signal? Take it now. No waiting, and ask no questions.

Regular readers will know that a while back I modified the Turtle by adding a brake that I can tap lightly when a breakout occurs. When I see a signal, I set my alarm for half an hour later, and then see whether the breakout is still in place.

That saved me some future grief today.

At last, one signal stayed  below the 20-day price low, giving a clear bear signal that, under my modified rules, I could play.

The SPDR Industrial Select Index (XLI), an exchange-traded fund that tracks blue-chip companies involved in industrial production and services, fell below it's 20-day low of $35.99, triggering a bear signal.

The stock has been in a sideways trend since early September. From a low of $35.75 on Sept. 5, the price rose to $38.07 on Sept. 14, and then declined into a narrower range, running roughly from a floor of $35.99 to a ceiling of $37.54.

The break below has carried the price to $35.87 and so qualifies as a true breakout from that narrower range. The next downside resistance would be the $35.75 starting point for the trend.

Every business sector has a story. That of industry is of slow recovery from the recession valley amid a longer-term decline and the likelihood of serious cuts in government spending, including defense, whose weapons systems are a major part of American industrial production.

Over the past year, XLI has broken out to the downside six times -- once each in November 2011, and last March, April, May, September and October.

Excluding Wednesday's breakout, the seventh of the year, XLI has sent a bear signal on 2.4% of trading, and one breakout -- 16.7% -- has been profitable.

The net loss for the breakouts has been $4.66 per share.

One thing I look at in my analysis of past breakouts is, before a breakout occurs, the degree to which I expected it to result in a profit. In other words, how strong does the breakout look to me?

I do this by looking at the five prior days of trading -- a week back. For a bear signal, I count the proportion of those days that had a lower low compared to the prior day's low. (For bull signals, I count higher highs.)

Of the six breakouts, the successful one, on May 9, also had the strongest expectation, 80%. Today's breakout also has an 80% expectation. The failed trades had expectations of 40% and 60%.

So perhaps that high expectation level is a tell-tale for a breakout with a higher likelihood of success. I'm not willing to declare that a rule yet, but it's worth further study.

XLI on average trades 12.1 million shares a day, sufficient to give it a major-league selection of strike prices with open interest running to four and five figures and a front-month at-the-money put bid/ask spread of 1.9%.

Implied volatility stands at 19% in the lower half of the six-month range. Volatility has been in a sideways trend with increasingly wide swings since late October.

Options are pricing in confidence that 68.2% of trades will fall between $33.94 and $37.86 over the next month, for a potential gain or loss of 5%, amounting to 10 times the daily range. For the next week, trades are expected to fall between $34.96 and $36.84 for a 3% gain or loss, or five times the range.

Options are trading actively, with calls running 39% above their five-day average volume and puts at 8% above average.

The fair price zone on today's half-hour chart runs from $35.84 to $36.10, encompassing 68.2% of transactions surrounding the most-traded price, $35.94. The stock is trading within the zone below the most traded price with two hours of trading left before the close.

XLI goes ex-dividend in March for a quarterly payout yielding 2.22% at today's prices.

Decision for my account: I took the trade on the strength of the breakout to the downside. Plus I'm a sucker for ETFs -- no make-or-break earnings announcement risk.

However, there are plenty of reasons for caution, not least of which is the history of past breakouts. 

I've hedged the position, structuring it as a bear call vertical spread, long the December $36 call and short the December $37 call for a $40 credit per contract. The break-even point, $36.81, is slightly below the Turtle stop/loss of $37.09.

References

My trading rules can be read here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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.

Tuesday, November 13, 2012

FXI: China falls.

The exchange-traded fund tracking the FTSE China 25 Index (FXI) -- the bluest of the Chinese blue chips -- fell below its 20-day low Tuesday morning in  1.8% downside gap. (Gaps aren't unusual for this ETF as it catches up with trading on the Chinese exchanges while the U.S. exchanges are sleeping.)

Two emerging-market funds, EEM and VWO, also sent bear signals by gapping below their 20-day lows, but they have heavy exposure in the country -- 18% for EEM and 17% for VWO -- so when China sneezes, these funds catch colds.

So in looking at these funds and the country funds, I want to avoid duplication, and I'm focusing my analysis on the country fund.

The FXI breakout itself is something I take seriously. The breakout level, $36.21, is only a dollar plus change above the bottom of a price spike that began Oct. 11 from $35.17 and carried the prices to a swing high of $38.15 on Nov. 6.

It is below the top of the gap that signaled the start of the spike.

The sideways trend from May into October had ceiling levels between $35.17 and $35.67, and today's low so far before an intra-day retracement to the upside is $35.65. That level means that real resistance has been pierced, but the retracement suggests the possibility of a bounce.

The market decline in China has come amid reports that the government plans to continue with a trial-run on collecting property taxes. It's a huge domestic issue, as The Economist reported in an excellent article last February.

It's worth noting, also, that FXI has had two downside breakouts in the past six months, neither of which produced a profit, meaning they hit the close point -- the 10-day highest price -- when it stood above the breakout price to the downside. So the historical odds are grim, to say the least, although with a very limited data-set.

FXI on average trades 18.2 million shares a day and has a very wide range of option strike-prices in its cupboard with open interest running to the four and five-figures. The bid/ask spread on front-month at-the-money puts is a narrow 1.8%.

FXI's implied volatility is running at 24%. It has been running sideways since September in the lower half of the six-month range.

Options are pricing in confidence that 68.2% of trades will fall between $33.44 and $38.48 over the next month, equivalent to 10 times the average daily range for the past 20 days, for a potential gain or loss of 7%. The implied one-week range is $34.75 to #37.17, five times the 20-day average daily range, for a potential gain or loss of 3%.

Trading in options is running above the five-day average volume, by 13% for calls and 84% for puts.

The fair-price zone on today's half-hour chart runs from $35.79 to $36.03, encompassing 68.2% of transactions surrounding the most-traded price, $35.95. There are several contenders for most-traded at high prices, running from $35.96 to  $36, and the stock is trading slightly above the most-traded level, so traders are leaning slightly to the upside with two hours and 45 minutes left in the U.S. trading day.

FXI goes ex-dividend in December for a semi-annual payout yielding 2.59% at today's prices.

Decision for my account: I took the trade, despite the failure of both bear signals of the last six months. They came during a clear sideways trend, as discussed above, and under such circumstances the Turtle Trading breakout levels can in fact act as reversal points.

However, mindful of the risk, I hedged the initial position as a bear call spread. I structured it as short the December $36.50 calls and long the December $37.5 calls for a credit of $31 per contract. 

This structure puts my break-even point at $36.81, slightly below a stop/loss level set at twice the average daily trading range: $37.09. Generally, I like my break-even to be at or beyond the stop/loss, but it was a trade-off to increase the credit. Even at this level, the beak-even is about half-way up the price spike that has ended.

Any additions to the position, as downside price targets are hit, will be in the form of February put options with a delta as close to 70 as I can manage.

References

My trading rules can be read here.

And the classic Turtle Trading rules on which my rules are based can be read here.

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.

Sunday, November 11, 2012

The Week Ahead: Inflation, retail, industry, cliff...

The week will be dominated by two events: The end of World War I and the beginning of the Battle of the Fiscal Cliff.

In between, look for some reports of market influence on inflation, retail and industry in a week distorted by a semi-holiday of global impact.

Sunday marks the 94th anniversary of the end of World War I. Since then, as the Great War has faded into history, the original Armistice Day has morphed into several successor holidays, with various degrees of observance.

In the United States, Veterans Day will be observed on Monday, with banks and bond markets closed. Stocks and options, however, will be traded in New York and Chicago on the regular schedule.

In London and Sydney, Remembrance Day is observed with ceremony but is not a public holiday, so those markets will be open for trading.

And in Tokyo, the day is of no particular significance and it will be just another session of the markets.

Two big U.S. economic reports will hit simultaneously at 8:30 a.m. Wednesday. The producer price index tracks the cost of stuff used in production, and retail sales is sort of a back-bearing on consumers' willingness to shop till they drop.

Of course, December's report on November retail sales will be far more interesting, since it will capture Black Friday, the start of the Christmas shopping season that, stores hope, will wash away the red ink and put them all in the black.

The most followed inflation report, the consumer price index, will be relased the next day, Thursday, at 8:30 a.m.

The industrial production report, out Friday at 9:15 a.m., will cap the week.

Friday is also the last day for November options to trade before expiring.

Potentially of greater financial significance than all the econ reports put together, the U.S. Congress' lame duck session begins on Tuesday, with lawmakers facing the task of finding a solution to the set of self-imposed mandatory and draconian budget cuts known as the Fiscal Cliff.

Leading indicators out this week (in order of importance):

The interest rate spread between 10-year Treasuries and the federal funds rate, reported continually during market hours.

The M2 money supply, out Thursday at 4:30 p.m. from the Federal Reserve.

The S&P 500 index, reported continually during market hours.

Average weekly initial jobless claims will be reported at 8:30 a.m. Thursday.

Other reports of interest:

Tuesday: Treasury budget at 2 p.m., showing the federal budget deficit.

Wednesday: Federal Open Market Committee minutes of the Oct. 24 meeting, at 2 p.m. The FOMC has been so open under Chairman Bernanke that the minutes have had far less impact than they did under more secretive Fed regimes.

Thursday: The Empire State manufacturing survey of New York enterprises at 8:30 a.m., the  Philadelphia Fed Survey of business conditions in the mid-Atlantic region at 10 a.m., and petroleum inventories at 11 a.m.

Friday: Treasury's international capital report at 9 a.m., tracking capital flows between the domestic U.S. economy and abroad.


I also like to keep an eye on the Baltic dry index of world shipping, updated daily.


Fedsters

San Francisco Fed Pres. John Williams speaks Wednesday, Richmond Fed Pres. Jeffrey Lacker on Thursday, and Atlanta Fed Pres. Dennis Lockhart on Friday. All are members of the Federal Open Market Committee.

Trading calendar

By my rules, as of Monday I can trade December vertical spreads and February single options and straddles. Of course, shares are good at any time.

Good trading!

Friday, November 9, 2012

PG: Downside Breakout

Procter & Gamble Co. (PG) near the end of Thursday's trading dropped below its 20-day low of $67.26, triggering a bear signal.

My practice for breakouts with less than half an hour to go in the trading day is to deal with it 30 minutes after the open. That preserves my mandatory half-hour waiting period that weeds out momentary breakouts.

The breakout still held good Friday morning.

Using traditional analysis, the low set Thursday and extended Friday can be seen as either a correction in an uptrend or the start of a new downtrend.

The present leg up began in late June from $59.07, reached a high of $69.97 on Sept. 25 and then reversed to a low of $67.26 on Oct. 23, which was down from a prior near-term correction low of $67.82 on Oct. 11.

That pattern is remarkably similar to what we see today. From the Oct. 23 low, the price gapped two days later and set a higher high of $70.83 with the announcement that PG had beat earnings estimates by 11%.

But then it retraced, beginning that day, to the lower low of $66.76 seen Friday.

Interpretations of that price pattern are of course mere ordered narratives imposed on a chaotic reality.

I think the chart is telling a story of a corrective downtrend that was interrupted briefly by an anomaly, and that has now resumed its course.

If that be the case, the prior correction was set Aug. 2 at $63.25, and PG must fall below that level to increase the likelihood of a mid-term downtrend. There is very little support along the way.

Despite the upside earnings surprise, analysts aren't entirely optimistic about PG's bullishness. Their collective wisdom gives it a negative 9% enthusiasm index.

Yet Procter & Gamble has 18% return on equity and relatively low long-term debt of 37% of equity.

Quarterly earnings have been helter-skelter back to 2010, without any sort of accelerating trend. Ten of the last 12 quarters have shown upside earnings surprises, and two have surprised to the downside.

Institutional ownership is low, at 55%, and the price is high: It takes $2.21 in shares to control a dollar in sales.

PG on average trades 7.7 million shares a day, but that supports a suprisingly narrow range of option strike prices, mostly at $2.50 intervals. However, open interest runs to the four and three figures, and front-month at-the-money bid/ask spreads are narrow, at 1.3%.

Implied volatility stands at 13%, at the low end of the six-month range. It has been falling sharply for three days.

Options are pricing in confidence that 68.2% of trades will fall between $64.49 and $69.57 over the next month, for a potential gain or loss of 4%, and between $65.81 and $68.25 over the next week, for a gain or loss of 2%.

Options are trading actively today, with calls at 73% above their five-day average volume, and puts at 42% above the average.

With 100 minutes left to trade, the fair-price zone on today's half-hour chart runs from $66.83 to $67.20, encompassing 68.2% of transactions surrounding the most0-traded price, $67.11. The stock is trading slightly below the most-traded level.

Procter & Gamble next publishes earnings on Jan. 21. The stock goes ex-dividend in January for a quarterly payout yielding 3.35% annualized at today's prices.

Decision for my account: I took the trade, hedging it as a bear call spread of options expiring Dec. 20, short the $67.50 calls and long the $70 calls, for a credit of $74 per contract. That structure puts my break-even point at $68.23, just below a stop/loss calculated as twice the average daily trading range. If a price decline triggers additions to the position, I'll buy puts expiring in with a delta of about 70.

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.

Thursday, November 8, 2012

MS: Anatomy of a Hedge

The investment company Morgan Stanley (MS) broke below its 20-day low late Wednesday, triggering a thorough ambiguous bear signal in the context of the chart.

Whenever I see a trading signal, one of my jobs as a trader is to decide how much credence to give it, and if I have my doubts, to determine whether there's a way I can take the trade while hedging against the risk.

MS has been trading sideways since mid-September in a range running form $18.57 down to $16.30. Tuesday's breakout came a mere 33 cents above the range floor. It's the third test of the breakout level, so I consider it to be a point of substantial resistance.

Three references that inform my discussion.
I'll focus on the last three days of trading.

Day 1 -- Tuesday -- saw MS reach a high of $18..24, which is 2.8% above the prior day's close. It broke past a 10-day high in reaching that level.

On Day 2 -- Wednesday -- MS gapped down at the open and hit a low of $16.63, or 8.6% below the prior day's close. Perhaps it was a case of post-election blues, traders fearful of the president's second term running for the exits.

On Day 3 -- Thursday -- I started to deal with the breakout, which came to late the prior day for me to impose my mandatory 30-minute waiting period before trading. The downside momentum had clearly slowed, with the trading staying near the lower end of the prior day's range.

This is a challenging decision. The Day 2 range was so wide, clearly a lot of the selling has already happened. And the Day 3 trading basically is going nowhere, confirming my assessment that the big decline is yesterday's news.

Yet, it's not uncommon for a stock to plummet, pause, and then work its way further down. But, the pause can also be a prelude to a reversal, sending the price up toward the ceiling of the sideways range.

There is no way to know.

One legitimate response would be for a trader shrug and move on to the next prospect. But MS is a highly liquid stock, trading 22.6 million shares a day -- the bluest of the blue chips. It's not every day that a company in the Top 10 volume leaders gives a trading signal.

 A second would be to sigh and wait for a move to begin in either direction. But Wednesday's sudden quantum leap shows that often there is no "begin" to a move. The move happens in the after- or pre-market trading, and a private trader can only deal with the consequences.

So I chose a third course of action, which is to take the trade, but hedge the position so that losses from a contrary move are limited and profit is possible even above my entry point into a bear position.

I structured the position as a bear call spread, meaning that I sold call options expiring in December at a strike price nearer the current price, and then bought calls with a strike further away from the current price.

A companion structure to the bear call spread is the bull put spread. As a class, they're called vertical spreads.

Since the bought calls cost less than my premium from selling the short calls, I get immediate cash that I can keep if I hold the position until the options expire.

In this case, I sold the $17 calls for $76 per 100-share contract, bought the $18 calls for $40 per contract, and as a result had a net premium of $36 per contract.

By selling the $17 call, I'm promising to deliver 100 shares of MS at that price on demand. Now, I don't own MS and will need to pony up $1,700 plus commissions to fulfill each contract.

That's a fairly large hit. So to ease the potential pain, I turn around and buy an $18 call option. That puts me in the driver's seat. I can demand that the guy I bought them from sell 100 shares of MS to me for a share price $18.

So for each contract, if I'm called out on the call I'm sold, I'll call out myself on the call I bought, and I'll only have to pay $100. Much nicer. Especially when I consider that I already got $36 net for opening the position. So my actual cost is $64.

Of course, my entry price on MS was $16.66, and that's where the position gets interesting in terms of channel breakouts. In normal trading -- buying shares or options -- $16.66 would be my break-even point -- above that I lose, below, I gain.

Not a good situation if there's a 50% chance that the price will indeed reverse to the upside.

My bear call spread, however, puts the break=even point at expiration at $17.36, meaning that if MS is trading even $1.30 above my entry point on Dec. 30, I'm still profitable.

My profit, at its maximum, comes about at the strike price for the option I sold, and it stays the same at expiration anywhere below that level. Anywhere below $17, the option I sold won't be exercised because the owner can buy the stock on the open market at a cheaper price than he can from me by using the option.

That's the trade-off. I limited my loss to $64 per contract, but I've limited my gain to what I got when I set up the position, $36 per contract.

Under my trading rules, if the stock does continue on to the downside, then I'll add to the position. And since the downtrend would be then be established, I would buy puts, with no limit on profit.

If it instead reverses, then I'll hang on to the bear call spread in the hopes that the price will  be below my break-even level six weeks from now. If yes, I've made money. If not, then I take my loss and move on.

How do I calculate potential profit on a trade where someone pays me?

I do it on the basis of my maximum risk. If my risk is $64 per contract -- the loss limit described above -- and my maximum possible gain is $36, then the yield is 56% plus change. That's a very nice return for a six-week investment.

I've gone into such detail because the MS chart is a clear example of a situation that calls for a hedged response to a trading signal. Such vertical option spreads are, anymore, my preferred method of establishing an initial position.

MS next publishes earnings on Jan. 14. The stock goes ex-dividend in January for a quarterly payout yielding 1.21% at today's prices.

Decision for my account: I took the trade, as described above.

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.

Wednesday, November 7, 2012

JPM: Political dive

A fascinating morning, with the S&P 500 diving 2.8% below yesterday's close.

Was it simple-minded analysis of the election results? (Republicans good, Democrats bad.)

Was it algorithms that built the election outcome into their trading rules?

Was it a coincidence? A fluke? A continuation?

The World Wonders. Who knows why the markets do what they do? Perhaps the best answer is, "All of the above."

The fact is that the S&P 500 hit a swing high of $14.74 on Sept. 14, and has been in a downtrend ever since. The index moved below its 20-day low on Oct. 12, triggering a bear signal under my rules. And today it moved below the 55-day low, triggering a bear trade among the more cautious Turtle Trading fans.

The health-insurance companies took a bit of a hit, but that was all ready underway. And so did the financials, which have also been ina downtrend since September.

Amid all the noise, JPMorgan Chase & Co. (JPM) came closest to satisfying my requirements, and also it allowed me to play the politically driven financials decline.

JPM pierced the lower boundary of its 20-day price channel, $40.87, triggering a bear signal. The move to a low today (so far) of $40.31 set a lower low following yesterday's lower high in a downtrend that began Oct. 17 from a swing high of $43.54.

JPMorgan Chase, headquartered in New York, is the largest bank in the United States measured by assets. Forbes has declared it to be the second largest public company in the world. It has its fingers in most financial pies. It is, in short, a player.

The political story behind JPMorgan Chase and the rest of big finance is that the Obama administration wants to impose stricter regulations on their business.

The problem with trading on that story is that the likelihood of increased regulation would change not a bit no matter who won Tuesday's election. Republicans control the House. They can block regulatory moves originating in the Democratically controlled Senate or White House. Had Gov. Romney won, then the Senate would be the effective blocking body.

So in terms of story, I treat today's large downward move -- 6.4% below yesterday's close -- with a lot of caution, and indeed the price has retraced to slightly above the breakout level.

Indeed, if you listen to analysts, you'll be bullish on JPM's prospects. The analyst enthusiasm index stands at 26%, up from 17% three months ago.

I wouldn't call JPM a growth stock by any measure. The company's return on equity is 10% -- more a slow and steady level -- and debt is way high, like that of most banks, standing 38% higher than equity.

Earnings have risen the last four quarters, although the two middle quarters formed a plateau. So far there's no reasonable basis to declare that earnings have been accelerating, although the most recent quarter, which saw a 22% rise, a year from now could well appear as a take-off point.

Institutions own 70% of shares, and the price is above par: It takes $1.72 in shares to control a dollar in sales.

JPM on average trades 18.5 million shares a day and supports a wide selection of option strike prices with open interest running at five figures near the money. The front-month at-the-money bid/ask spread for puts is two-third of a percent.

Implied volatility stands at 29%, in the bottom half of the six-month range. It has been rising at a shallow angle since mid-October.

Options are pricing in confidence that 68.2% of trades will fall between $37.48 and $44.40 over the next month, for a potential gain or loss of 8%, and between $39.28 and $42.60 over the next week, for a gain or loss of 4%.

The market for options is hopping, with calls running at more than four times their five-day average volume, and puts at nearly three times the average.

Today's fair-price zone on the 30-minute chart runs from $40.51 to $41.30, encompassing 68.2% of transactions surrounding the most-traded price, $40.97. The zone width is 2%. With two and a half hours to go before the close, the stock is trading just below the most-traded price.

JPMorgan Chase next publishes earnings on January 9. The stock goes ex-dividend in January for a quarterly payout yielding 2.93% at today's prices.

Decision for my account: I took the trade on the basis of the signal and supporting confirmation. I structured it as a bear call spread, short the December $42 call and long the $43, for a 43% yield on risk. The structured places the break-even point at $42.30, slightly below my standard initial stop/loss of twice the average daily trading range, which worked out to $42.38.

I don't set stops on vertical spreads. Any additions to the position will be in the form of long put options with a delta of around 70.

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.

Tuesday, November 6, 2012

JBL: Decisions, decisions

A tough day for trading decisions. I got four breakouts in short order this morning, and because of my limit of two new stock/option positions each day, I had to do triage to pick my trade.

So, how to choose?

The original Turtle Trading system, upon which my trading rules are based, uses a strict time-order method. If you get a signal at 9:30 a.m., and another at 9:45 a.m., then the 9:30 a.m. position will be opened first. No questions. No thought.

But the Turtles were trading in the limited world of futures. Stocks and their options are quite a bit more numerous and have a lot more moving parts.

So I make a conscious choice rather than just relying on first come first traded.

The signals were on GS, AMTD, JBL and PAY. How to choose?

Rather than having strict rules for selecting, I tend to operate within a spectrum of tendencies. I tend to like higher volume over lower volume.

I prefer stocks whose breakouts are in the direction of the company's fundamentals and analyst opinions. I follow Zacks for this assessment. If a stock breaks out to the upside but is rated "strong sell" by Zacks, then I'm less interested.

On the chart, as I discussed on Monday, I'm looking for breakouts that are really moving beyond support or resistance, rather than simply crossing an arbitrary 20-day-high level. I may move a break-out level in order to achieve that end, thereby killing any immediate trade.

I prefer stocks whose options have strike prices at $1 intervals. Options with low open interest are deal killers, as are those whose options are so expensive they would put my exposure beyond what my rules allow.

Some fell based on illiquid options and one, GS, because the price is high.

The survivor of all of this assessing was Jabil Circuit Inc. (JBL), which on Tuesday broke above its 20-day high of $18.28.

Now, the stock has a very bearish analytical rating from Zacks, but its earnings in late September beat analysts' expecations by 8%, so I'm discounting the contradiction somewhat. (This is what I mean by "tendencies"; things aren't hard and fast, but rather its a "yes but no or maybe" sort of inner dialogue.)

The stock on Oct. 15 hit a swing low of $16.82, ending a decline from $23.95 in late August. From there the price rose for two days, retraced almost the entire rise, and then on Oct. 23 began an near-term uptrend from $16.84 that is still happening.

It's not that analysts hate JBL, which, from its St. Peterburg, Florida headquarters, directs the manufacture of electronics for big enterprises and their products, such as aerospace, automotive, defense, medical, solar and networking industries.

They give it a 27% enthusiasm index -- not bad -- although it's down from 60% two months ago.

And the return on equity is excellent, at 21%, although that's down from 23% the prior quarter. The long-term debt is a bit high, at 79% of equity.

The company had big changes at the top last month. A big customer, Research-in-Motion, has had problems for awhile. It's not that JBL is awful, but for some it just sort of gives off a nervous-making vibe in the eyes of some.

So who do I believe? The chart or the experts?

In truth, I think Zacks has gone too far with its bearish rating. The financials to me seem better than that. But their analysis goes far deeper than mine, so I have little standing to disagree with them.

If indeed their forecast, covering the next one to three months, is correct, then JBL will present a useful stress test to my system of structuring and exiting trades.

Quarterly earnings have been on a plateau since 2011, although the company has been consistently profitable.

Institutions own 84% of shares, and the price is in the cellar; it takes only 22 cents in shares to control a dollar in sales.

JBL on average trades 3.2 million shares a day. It has a wide selection of option strike prices, with open interest running to the three- and four-figures. The front-month at-the-money bid/ask spread is 4%.

Implied volatility stands at 38% in a six-month range running from 31% to 52%. It has been working its way higher since mid-October.

Options are pricing in confidence that 68.2% of trades will occur from $16.48 and $20.48 over the next month, for a potential profit or loss of 11%, and from $17.52 to $19.44 over the next week, for a 5% profit/loss.

JBL's options are in the doldrums today, with calls at 89% of their five-day average volume and puts at 28%.

The fair-price zone on today's 30-minute chart runs from $18.19 to $18.49, encompassing 68.2% of transactions surrounding the most-traded price, $18.43. With 90 minutes worth of trading left, the price is near the top of the zone.

Jabil Circuit next publishes earnings on Dec. 19. It goes ex-dividend on Nov. 13 for a quarterly payout yielding 1.73% annualized at today's price.

Decision for my account: I took the trade despite the bad rating from Zacks, for the reasons discussed above. I structured the position as a December bull put vertical spread, short the $18 strike and long the $17, for a 25% yield on risk. This structure places the break-even point, $17.66, near my stop/loss level of  $17.38. (The stop/loss is double the average daily trading range.)

I don't place actual stop/loss orders on vertical spreads, instead relying on the spread structure to limit my losses (and also gains). If the price continues to rise and triggers me to add to the position, the additions will be in the form of long March call options.

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.

Monday, November 5, 2012

MET and UNH: Breakout? Maybe not...

My trading rules use the 20-day high or low to generate bull and bear signals. I lifted the method from the Turtle Trading price-channel breakout system.

Which implies a question: What's magic about 20 days? Why not 15 days? Or 30? Turtle Trading has an option where the 55-day high or low is used for signalling. Why not 65 or 47?

It's true that 20 days is about a month, and 55 days is about a quarter. A month may be significant in the life of some companies. A quarter is certainly significant for nearly all enterprises that use normal accounting practices. But a week, 5 days, is also significant, and it has no place in the Turtle Trading system.

And no one has ever really tied those periods into a rigorous correlation with price movements. To use them, in fact, is an act of faith.

In dealing with this issue, I've come to think of the the 20-day breakouts as a rough approximation. This week I have 241 stocks in the equity pool I track, plus dozens of currency pairs and exchange-traded funds.

I need some clearly defined easy to see event so that I can set my alerts and hang around drinking green tea rather than staring at a screen. The 20-day price extremes, or price channels, fulfill that function admirably.

But once the breakout has happened, things can get much more ambiguous.

Case in point: Two health-insurance providers -- Metlife Inc. (MET) and UnitedHealth Group Inc. (UNH) -- both broke below their 20-day lows this morning, I presume in response to polls increasing the likelihood that Pres. Obama will win re-election, ensuring that his health-insurance reforms will continue to clamp tight regulation on the industry.

But did they truly beak below support levels?

MET, stuck in a months-long sideways trend, dipped below it's 20-day low of $34.26, but the low had risen from $33.88 on Friday. The former represents a moving 20-day low rather than a static support level.

And $33.65, give or take a nickel or so, was a significant resistance level from Aug. 30 and one that has played a role in price moves four times since Aug. 1.

Which is the true support? Clearly, the $33.65 level.

And MET proved how weak the $34.26 level is as a breakout indicator by staying below it briefly, than then retracing back to the upside.

UNH has a wildly different pattern because the price has been in an uptrend since Aug. 2, although the price moves have been more extreme. Its 20-day low triggered today's bear signal is $55.34, but the channel boundary rose to that level on Oct 31, less than a week ago.

So it is also a mobile 20-day low, which is suspect.

Because of the uptrend, there is no level that has been tested repeatedly. However, a trend line drawn from the start of the uptrend, at $50.32 on Aug. 2, through the first retracement low of $52.58 on Sept. 12 gives a trendline level today of about $55.45.

That's not far from a low, around $55.35, that has been tested four times in the past nine trading trades. Arguably, the true breakout level is somewhere within the range of $55.35 and $55.45, and the 20-day low gave a slightly delayed indication of the breakout, although still on the same day.

My point is that there is nothing magic about 20 days. It is a shout out saying, Hey, look at me!

The Turtle Trading rules from the 1980s were quite rigid about always taking trades on a channel breakout.

Today, with our 21st century charting tools, I think we can do better than the old Turtles. One way to do that is to adjust the breakout level.

In the case of MET, the Turtle breakout was above the chart breakout, so I lowered the breakout level to $33.59, and the price hasn't come close to it yet.

In the case of UNH, the Turtle breakout was below the chart breakout, so the proper course of action if the price remained below the chart breakout level would be to take the trade, even if the price had pulled above the Turtle breakout level.

Bottom line: As a trader, I want to base my decisions on true breakouts, not faux breakouts demanded by rigid rules that may not apply to the chart. Trendlines and support or resistance levels are tools that can be used to determine the true breakout level, and as a trader I will show no hesitation about adjusting the breakout level to match the chart.

I've adjusted my trading rules in the Entry section to allow for breakout-level adjustments. Also, I've removed the requirement that a stock's financial and analyst bias be in the direction of the breakout, since my use of vertical spreads for the initial position lessens the need for an immediate trending follow up to the breakout. (I discussed the use of vertical spreads in a post that you'll find here.)

Decision for my account: I passed on MET because it remains above the chart breakout level, but left an alert in place in case it breaks out again. 

I look UNH because it remained below the chart breakout level (and also the Turtle 20-day low). I structured the position as a December bear call vertical spread for credit, short the $57.50 strike and long the $60. This sets the break-even point at $58.05, a dollar above a stop/loss set by my rules at double the average daily trading range, for a 28% yield on risk.

Under my rules, I don't set stop/losses on the verticals that I use as my initial positions, since verticals define and limit losses (and also gains). Any additions to the position will be March long puts with a delta of around 70.

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.

Sunday, November 4, 2012

The Week Ahead: U.S. elections and global trade

Tuesday's presidential election overshadows the week, and it is in a way the greatest leading economic indicator of all. The vote will determine the economic policies of the next four years that will, in turn, have an impact on the economy and all of the other indicators.

However, I don't for a second believe in a simple partisan interpretation of the results, as some employers across the country have been doing in letters to their workforce implying that an Obama win will result in layoffs and economic stagnation.

The economy is bigger than the president, bigger than the government, indeed bigger than the country. It is a balance struck among an uncountable number of public and private interests and decisions, not to mention the impact of such random events as earthquakes, hurricanes and rogue computers causing flash crashes.

The Associated Press' Nancy Benac has put together a fine hour-by-hour guide to election night. You can find it on Yahoo! here. The first statewide poll closings are at 7 p.m. Eastern.

There is but one major indicator out this week: The international balance of trade will be released at 8:30 a.m. on Thursday. It is usually interpreted in the lens of exports good, imports bad, China dangerous. Although in fact, whether it be imports or exports involving China or not, someone in the United States is profiting; otherwise, they would be making the trade.

Leading indicators out this week (in order of importance):

The interest rate spread between 10-year Treasuries and the federal funds rate, reported continually during market hours.

The M2 money supply, out Thursday at 4:30 p.m. from the Federal Reserve.

The S&P 500 index, reported continually during market hours.

Average weekly initial jobless claims will be reported at 8:30 a.m. Thursday.

The index of consumer expectations in the University of Michigan/Reuters consumer sentiment report will be released Friday at 9:55 p.m.

I also like to keep an eye on the Baltic dry index of world shipping, updated daily.

Other reports of interest:

Monday: The Institute of Supply Management's non-manufacturing index, at 10 a.m.

Wednesday: Petroleum inventories at 10:30 a.m. Wednesday.

Friday: Import and export prices at 8:30 a.m.

Trading calendar

By my rules, as of Monday I can trade December vertical spreads and February single options and straddles. Of course, shares are good at any time.

Don't forget to vote Tuesday if you live in the U.S., and good trading!

Friday, November 2, 2012

UNG: Gas doesn't float

The United States Natural Gas Fund (UNG), an exchange-traded fund that tracks natural gas prices, gapped down below its 20-day low at the open on Friday, triggering a bear signal under my trading rules.

UNG has a very poor correlation with the S&P 500 -- only 7% -- so I like it for the diversification it brings to my holdings. Even so, today's market stories are linking the UNG fall with the broader market, so go figure.

The fund is prone to dramatic reversals on occasion, and it also tends to hold to a trend for awhile once it has begun. Volatility and persistence, of course, are the meat and potatoes of a trend follower.

UNG began its present uptrend in April from a low of $14.25 and began its most recent leg up from a low of $17.69 on Aug. 28. The movement carried the fund to a swing high of $23.38, just a cent above the 55-day high, on Oct. 19. That breakout immediately reversed and eight days carried the price down to its present bear state.

The near-term low in the zig-zag up was $21.47, and today's opening of $21.30 fell below that, marking a lower low and putting UNG into a downtrend using traditional support and resistance analysis.

UNG on average trades 7.8 million shares a today and supports a wide selection of option strike prices with four-figure open interest and a 1.3% bid/ask spread for front month at-the-money puts.

Implied volatility stands at 38%, near the bottom of the six-month range. Volatility has been rising, albeit slowly, since Oct. 22.

Options are pricing in confidence that 68.2% of trades will fall between $18.56 and $23.19 over the next month, for a potential 11% gain or loss, and between $19.76 and $21.99 over the next week, for a 5% gain or loss.

Options are trading 15% above their five-day average volume, with calls leading at 19% above average, compared to 11% above average for puts.

Today's fair-price zone on the 30-minute chart runs from $20.99 to $21.43, encompassing 68.2% of transactions surrounding the most-trade dprice, $21.35. The stock is trading below the zone with a bit more than two hours to go before the close.

My entry point was $21.39, and the first point to add to the position was below $21.07, which the price hit less than three hours after the breakout. So whatever is happening with UNG, it's happening in a big way.

Decision for my account: I took the trade, structuring the initial position as a bear call spread, short the December $22 call and long the $23 for a $32 premium per contract. This places the breakeven point at $39.75, near the initial stop/loss of $39.73. The return on risk is 47%.

Of course, I don't set a stop/loss on spreads. The maximum loss point, $38.99 in this case, serves that function.

After the tripwire for adding to the position was sprung, I structured the addition as long April $25 put options with a delta of 70. The stop/loss for the long puts is a trailing stop placed at double the average daily trading range (called "N" in my rules and in the Turtle Trading system) from the entry point.

The way my system works, if UNG reverses then my stop/loss on the long options will be triggered, causing the shares to be sold, and the initial short vertical spread will stay on my account until it expires in December (or until I close it a week before expiration).

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.