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.

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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