Thursday, January 17, 2013

RGR: Trading the firearms frenzy

As President Obama proposed a program to bring a modest degree of regulation to firearms use, Sturm, Ruger & Co. (RGR) moved sharply above its 20-day high of $49.45. Ruger, headquartered in  Southport, Connecticut, is the fourth-largest firearms manufacturer in the United States.

The price move covered 6.4% intra-day on Wednesday, and continued today for a total rise for the two days, at the peak, of 11.2%.

Ruger and the other firearms makers are the ultimate in news stocks since 20 children and six adults were killed a month ago by a mentally ill gunman at an elementary school in Newtown, Connecticut.

Gun shops have been crowded with buyers saying they want to beat what they fear will be a ban on firearms -- unlikely, since the Supreme Court says the government can't do that.

Rugers' corporate website has a blaring headline reading "Protect Your Rights! Gun rights are under attack. We, the silent majority, need to speak up now and make sure our voice is heard."

As always, gun rights and politics are walking hand in hand, and not very silently, at that.

It is easy to dismiss RGR's breakout as a bump up inspired by gun-owner frenzy. The statistics, however, tell a different tale.

RGR has broken out to the upside 10 times since Janaury 2009, two of those last year, in June and November.

Overall, 60% of RGR's upside breakouts have been profitable, with an average yield of 21.7%. These are serious odds in favor of a success that go beyond the headlines of the day. When the yield is adjusted for the success rate, it works ot to 13%, which is extraordinarily high.

As a trader I have a huge dislike of stock movements based on news. I always keep in mind the words said to have been uttered by the financier Nathan Rothschild after he made a huge profit from the Battle of Waterloo: Buy on the sound of cannons; sell on the sound of trumpets.

In the gun debate the trumpets have sounded. The cannon were heard a month ago. It's clear that a few small regulatory things will be done, most likely in the area of more effective background checks for gun buyers, but nothing that is likely to cut into Ruger's profits.

What the chart shows, in my opinion, is a small buying panic that echos the panic at gun-store counters.

RGR, however, could be hurt by the revulsion against unregulated guns that has come in the wake of the Newtown Massacre. Public pension funds in New York, California and Chicago  have said they will either divest or stop buying shares in firearms manufactuers.

If that sentiment became general and reduced demand for shares, it  could have a downside effect on RGR's price.

The current upleg, which began Dec. 18 from $40, fits neatly within a sideways range that has been in force since last July.

The stock has been in an uptrend since late 200i8, punctuated by some sharp corrections that never produced a lower low. The uptrend will be confirmed as being still in force if the price moves above the $60.11 high of Nov. 30.

RGR was one of eight stocks that broke beyond their price channels on Wednesday, five to the upside and three to the downside. I removed four stocks from consideration because of earnings announcements scheduled within the next 30 days.

The remaining four were all confirmed in this morning's trading. Their success rantes range from 37% up to 84%, with average yields running from 3.5% up to 21.7%.

RGR is followed by so few analysts that I can't calculate a meaningful enthusiasm index. The half a handful that follow the company are neutral or negative as to its prospects.

Which is fairly amazing for a company with a 39% return on equity and no debt, one whose earnings have accelerated since the last quarter of 2010, which has been profitable for at least the last 12 quarters, and which has always surprised to the upside.

If I were trading the income statement and balance sheet, I would fall in love with Ruger instantly.

Institutions own 92% of RGR shares and have bid up the price. It takes $2.18 in shares to control a dollar in sales.

RGR on average trades 624,000 shares a day and supports a modest selection of option strike prices with open interest near the money in the three- and four-figures. The front-month at-the-money bid/ask spread on calls is a fairly narrow 3.9%.

Implied volatility stands at 48%, near the middle of the six-month range. It has been gently falling since Jan. 14.

Options are pricing in confidence that 68.2% of trades will fall between $44.46 and $59.18 over the next month, for a potential gain or loss of 14%, and between $48.29 and $55.35 over the next week.

Options are trading well above their five-day average volume, 77% above for calls and 87% above for puts.

The volatility and fevered options trading suggest that RGR is in the midst of a highly speculative situation. The question a trader must ask: Is it speculation based on the news, or on business prospects?

The fair price zone on today's 30-minute chart runs from $51.44 to $52.42, encompassing 68.2% of trades surrounding the most-traded price, $51.81.

With three hours before the close, RGR is trading near the most-traded price, and the stock has moved very little throughout the day. The big gain came with an opening gap. That's when the retail orders generally come into play. There's a reason why the first hour of the trading day is called "amateur hour".

Ruger next publishes earnings on Feb. 25. The stock goes ex-dividend in February for a quarterly payout yielding 2.5% annualized at today's prices.

Decision for my account: Nathan Rothschild had it right. The cannon have fallen silent. I hear the trumpets, so I'm not buying.

There is way too much about today's trading that reminds me of a guy who was scathingly critical of the whole idea of trading charts. I asked him how he trades. Well, he replied, I like on to Yahoo! Finance and see what everyone is saying about the stock, and then, if they're saying good things, I buy it.

No one can really know, but I think the speculation is based on news, not expectations, and the smart trader always remembers that today's headlines are tomorrow's bird-cage liner.

The options have sufficient liquidity to support a trade, and the high volatility would make it a potentially high-yielding one that would provide a 6.8% cushion on a bull put options spread, meaning the trade would be profitable at a mid-February expiration down to $48.30.

But, it would be a news play, and I hate those. Also, the rise has stalled this afternoon, suggesting that upside momentum may be exhausted, temporarily at least.

And what possible news could there be going forward to inspire a further rise? President Obama's gun regulation proposals will now get mired in the Congressional tar pit, from which few proposals emerge intact, if at all. The NRA's grand battle for gun rights will wither for lack of new outrage. I doubt that the president will be making new proposals. 

What was a pair of complementary grand crusades for gun regulation and gun liberty will become the raw material for legislative sausage making.

There's little in that to support a continued explosive rise in RGR shares. 

Two ways to play it going forward; Wait for a break above the high of $60.11, the classic resistance level, or wait for a retreat below the 20-day moving average and then a fresh breakout, when the speculation has cooled a bit and the news is less dramatic.


My trading rules can be read here. (They don't talk about the trend score because I'm still developing the tool.) A discussion of recent modifications to my trading methods, which haven't yet been incorporated in the original write-up, can be found here.

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

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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