Thursday, February 28, 2013

TPX: Ignoring the Grand Canyon

Tempur-Pedic International Inc. (TPX) broke above its 20-day price channel on Wednesday and continued to trade above the $41.11 breakout level today, confirming the bull signal. The move was prompted by a strong sales report for January.

Since January 2009, when my data begins, TPX has sent 20 bull signals, 11 of them profitable, for a success rate of 55% and an average yield of 19.7%. The yield, adjusted for the success rate, gives a score of 10.9, which is quite high.

In the past year TPX has broken out twice to the upside. Both of those breakouts were profitable,  and highly so, for an average yield of 24.5%.

TPX on the chart has since May been recovering from a sharp decline that carried the price from $87.43 on April 18 down to $21.05 on June 7.

Since then the price has stairstepped higher to a swing high, so far, of $43.45 on Jan. 25. It has since retreated from that level to a retracement low of $35.08 on Dec. 25.

It's a fairly bullish chart, as long as I ignore the awful 76% price drop. But ignoring a hole of that magnitude is a big ask, in the same league as ignoring the Grand Canyon.

The TPX canyon was marked by a 49.8% downside price gap on June 6, after the company told analysts it expected sales to be 3% to 5% lower.

The January swing high touched the top of the gap, and the price retreated thereafter.

I think it will be a hard push to get the price above that level. Many who held shares pre-gap will be eager to get out at the pre-gap price, putting an effective ceiling on future price rises.

At this point I can end my analysis. The position of the price relative to the gap is a deal-killer for me. A push substantially above the gap top would renew my interest, but absent that...

But let's at least see whether I'm alone in my skittishness about TPX.

Analysts are treating the stock as a loser, with a negative 38% enthusiasm rating. (I've never quite worked out what to call a negative enthusiasm rating. Loathing score, perhaps?)

The most interesting point about the financials is the debt, which is at a level amounting to 98% of assets. That gives some shareholder equity in the most recent quarter, but barely, and the company had negative equity to two preceding quarters.

I don't generally allow the financials or the analysts to determine my trades, but in this case, the negative analyst rating and the crippling load of debt argue strongly, in my opinion, against a bull play.

The options grid gives a good selection of strike prices with open interesting running to the three figures. The front-month at-the-money calls have a moderately wide bid/as spread of 7.5%.

TPX on average trades 2.2 million shares a day. The company next publishes earnings on April 15.

Decision for my account: I'm not opening a bull position in TPX because of the positioning of the price in relation to last year's gap. See my discussion above for details.

References

My trading rules can be read here.  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.

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, February 27, 2013

Posting Schedule

I'm back in the United States following a few weeks of travel in East Asia, so my posting schedule will return to normal, generally mid-way through the trading day, at least insofar as that schedule is consistent with a major case of jet lag.

SINA: Bear signal on Chinese Internet giant

Update: I closed the position on March 22 at $50.75 when the price crossed above the 10-day price channel, for a 1% loss on the underlying stock price. The entry price on the underlying was $51.26. My initial vertical credit spread produced a 13.2% profit on the risk at entry, compared to a maximum potential gain of 31.6%.

The Chinese online portal and social media company Sina Corp. (SINA) has broken below it's 20-day price channel, sending a bear signal amid a retracement of a rise that peaked a weak earlier.

The rise carried the price from $41.41 on Dec. 10 up to $58.77 on Jan. 24. From that point the price retraced almost to the lower price channel boundary, but then rebounded to a new high of $59.60 on Feb. 29 before tumbling through the lower boundary, $51.91, on Tuesday.

The stock continued to trade below that level the next day, confirming the bear signal.

The chart is strongly biased to the bear side.

SINA has broken out to the downside 17 times since January 2009, when my data begins, and 52.6% of those breakouts has produced a profit, averaging 14.5%. Adjusting the average profit by the success rate produces a score of 7.6%, well above the 5% minimum that I prefer.

In the past year SINA has produced bear signals three times, two of which were profitable.

The retracement carried the price to a lower low, breaking the near-term uptrending pattern. Longer term, the price has been stair-stepping downward since peaking at $147.12 in May 2011.

However, today's trading has gone nowhere. It's not quite the spinning top hesitation pattern on a candlestick chart, but it's close to, suggesting that the very near term decline may have, momentarily at least, run out of energy.

Sina's micro-blogging social networking service, Sina Weibo, has more than 140 million users and holds around 57% of that Twitter-like medium's market in China. Along with Baidu and Tencent, the Shanghai-based Sina is a major player in China's Internet media market.

Its primary exchange for trading is the U.S.-based NASDAQ.

Despite the bearish chart, analysts are strongly optimistic about Sina's prospects; their collective opinion gives the stock a 62% enthusiasm rating.

Certainly, that sunny optimism isn't backed up by the financials. Return on equity the most recent quarter was a negative 0.14%, and the quarter before that wa a miserable, yet positive, 0.33%.

The company reports no long-term debt, but still, a company with high analyst ratings and hardly any returns is a classic: An Internet stock trading on stories and dreams rather than performance. Which is OK, of course, if you like that sort of thing.

Quarterly earnings were depressed in 2012 compared to 2011, and 2011 was down compared to 2010. The company is making money -- SINA has shown a loss in only one of the last 12 quarters. Earnings have shown positive surprises in 10 of the last 12 quarters, and negative surprises in two.

Institutions own 72% of shares, and the stock price is extremely high: It takes $6.54 in shares to control a dollar in sales.

SINA on average trades 3.6 million shares a day, sufficient to support an excellent options grid with open interest in the three- and four-figures. The front-month at-the-money puts have a fairly narrow 2.5% bid/ask spread.

Implied volatility stands at 45%, near the low end of the six-month range. Volatility was rising through Tuesday's breakout but has declined sharply today.

In the analysis that follows I use two standard deviations in several places. Two standard deviations is the width of a price range that will contain 68.2% -- about two-thirds -- of trades.

Options are pricing in confidence that 68.2% of trades will fall between $44.46 and $57.86 in the next month, for a potential gain or loss of 13%, and between $47.94 and $54.38 in the next week.

Trading in options today is rather sluggish, with both calls and puts showing volume about a third of the five-day average. This is another argument in favor of the idea that the decline, for now, has run out of steam.

The fair-price zone on today's 30-minute chart runs from $50.79 to $51.46, encompassing 68.2% of transactions surrounding the most-traded price, $51.20. SINA is trading at about the most-traded price with two hours left in the trading day.

Sina Corp. next publishes earnings on May 13.

Decision for my account: I've opened a bear position in SINA, structuring it as a bear call spread, short the April $55 calls and long the April $57.5 calls. The position is profitable at a price at expiration up to up to about $55.60, with a potential top yield of about 32%.

References

My trading rules can be read here.  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.

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.

Saturday, February 23, 2013

INFY: Fails the odds test for recent breakouts

The Bangalore, India tech company Infosys Ltd. (INFY) broke above its combined 20- and 55-day high for a second time since mid-January, when a 5.5% earnings surprise prompted a quantum leap in price.

The first breakout, on Jan. 23, was unconfirmed, as the price closed below the breakout level. The second breakout, above $52.84 on Friday, awaits confirmation in Monday's trading. The price in the second instance peaked at $53.93 and then pulled back, but still closed above the breakout level.

INFY has broken beyond the 20-day price channel 70 times in the past four years. Of the 40 breakouts to the upside,  55% produced profits, with an average yield of  7.5%. Adjusting the yield for the success rate produces a score of 4.1%, slightly below the 5% level that I prefer.

In the past year INFY has broken out eight times to the upside, with only two successes.

At this point I can end my analysis. A high four-year success rate that is unconfirmed by the past year's success rate is a deal killer.

A look at the longer-term chart trends confirms the wisdom of caution, but also suggests guarding against over-caution.

INFY is prone to sudden moves on high volume, but it has been trading a series of lower highs and lower lows since January 2011.

However, the most recent quantum leap carried the price to a higher high compared to the prior swing high. So, by the book, it looks as though it could be a trend reversal, but it would take a break above the $61.48 high set in October 2011 to nail it.

Bottom line: I can wait. If INFY truly is reversing its trend, there will be future breakouts that will bring the trailing year's success rate up above 50%.

INFY was one of 29 breakout among my universe of 1,848 stocks analyzed from Friday's session. The universe was composed of stocks and exchange-traded funds rated by the ratings aggregator Zacks with an average volume the past 10 days of 1.5 million shares or greater and a breakout success rate in either the bull or bear direction of greater than 50%.

Three stocks were excluded because they had earnings within the next 30 days, and the rest failed to show a success rate of greater than 50% from breakouts in the same direction as Friday's.

INFY was the sole survivor meriting further analysis.

Decision for my account: I won't open a bull position on INFY because its breakouts the past 12 months have failed to show a sufficiently high success rate, above 50%.

References

My trading rules can be read here.  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.

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.

The Week Ahead: GDP++++, plus Bernanke

The government's second attempt to calculate the 4th quarter gross domestic product headlines the week, but there are a collection of other heavy hitters: New home sales, durable goods orders, personal income and outlays and the much watched manufacturing index from an industry group.

The gross domestic product will be released at 8:30 a.m. Eastern on Thursday. Altogether, the government makes three estimates for a quarters GDP; the final will be out in late March.

Generally, the second and third reports are refinements of rather than revolutions overturning the initial estimate, but I watch them closely, just in case.

The Realtors will report new home sales at 10 a.m. on Tuesday. This is the smaller part of the market; the governments existing home sales statistics are the broader measure. However, with a large number of new houses left unsold by the Great Recession, the new home sales figures are an indicator of how well that inventory is being reduced.

Durable goods orders, out at 8:30 a.m. on Wednesday, are in many ways a measure of consumer sentiment: To what extent are families and companies sufficiently confident that they are willing to commit to big-ticket purchases.

Personal income and outlays will be released at 8:30 a.m. on Friday. They are the answer to the perennial question, "How'ya doin'?" From income and outlays come the savings rate: How much are way spending and how much are we socking away for a rainy day.

Also Friday, the Institute of Supply Management releases its ISM manufacturing index, the result of a surve of more than 300 manufacturing companies. Released at 10 a.m.

And Fed Chair Ben Bernanke delivers his semi-annual face-off with the Congressional committees. In my book, it's more fun that pro-wrestling!

And, potentially, the end of the world as we know it. The across-the-board spending cuts voted by Congress are scheduled to kick in on Friday. The Obama administration is making the case for serious consequences should it happen. The Congressional Republicans are saying, basically, Oh, pshaw! No big deal!!

Leading indicators (in descending 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, at 4:30 p.m. Thursday.

Vendor performance, also called the delivery times index, from the ISM's manufacturing survey , at 10 a.m. Friday.

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

Average weekly initial jobless claims, at 8:30 a.m. Thursday.

Index of consumer expectations from the Reuters/University of Michigan consumer sentiment report, at 9:55 a.m. Friday.

Other reports of interest:

Monday: The Dallas Federal Reserve Bank's manufacturing survey of Texas manufacturing, at 10:30 a.m.

Tuesday: The S&P Case-Shiller home price index, which tracks prices in 20 metro areas, at 9 a.m., and the government's consumer confidence index at 10 a.m. Bernanke testifies before the Senate Banking Committee at 10 a.m.

Wednesday: Pending home sales -- contracted but not closed -- at 10 a.m. and petroleum inventories at 10:30 a.m. Bernanke testifies before the House Financial Services Committee at 10 a.m.

Thursday: The Chicago Purchasing Managers index of business conditions in Chicagoland, at 9:45 a.m.

Friday: Motor vehicle sales throughout the day, the Purchasing Managers' index just before 9 a.m. and construction spending at 10 a.m.

I also follow the Baltic dry index, released daily, tracking the volume of global maritime shipments of coal, iron ore, grain and other raw materials.

Fedsters

Chicago Fed Pres. Charles Evans, a member of the Federal Open Market Committee, speaks on Thursday.

An FOMC alternate, Dallas Fed Pres. Richard Fisher, also makes an appearance on Thursday.

Trading calendar

By my rules, we're at that awkward point where it's late for March option spreads having short legs and early for the April spreads. So trading I'm trading June options for single calls and puts and the long vertical spreads through Thursday. From Friday, I'll start trading March short vertical spreads. Of course, shares are good at any time.

Good trading!

Thursday, February 21, 2013

ORIG: A question of logistics

Ocean Rig UDW Inc. (ORIG) broke below its 20-day price channel on Thursday, giving a bear signal within a pattern that could, at this point, as easily be interpreted as a correction within an uptrend.

The breakout level, $15.40, is above the swing low of $14.95 set Jan. 16 in a stair-step upward from $14.34 on Dec. 31 to a swing high of $17.99 on Jan. 30.

A fall below the $15.40 level would suggest that the uptrend has reversed.

ORIG has broken out nine times since trading began in September 2011, four times to the downside. Three of those four signals produced a profit, with an average gain from winning trades of 8.2%. Adjusting the gain by the odds gives a score of 6.2%, which is excellent.

The stock lacks an extended trading history, meaning there aren't many breakouts on which I can base my odds.

Longer term the chart shows major resistance at $18.40, a level tested five times since trading in ORIG began in October 2011. The price is approaching that level again, and if history means anything, it suggests a reversal will be at hand.

Or not. History is not prophecy.

Ocean Rig, a Stavanger, Norway offshore drilling company, is a subsidiary of the shipping company DryShips Inc. (DRYS), which this month has been reducing its stake in ORIG. The share sales concluded on Feb. 14 and left DryShips with a 59% stake in Ocean Rig.

ORIG doesn't have a wide following among analysts. The handful in its coterie are enthusiastic about its prospects.

The five quarters of earnings available, given the youth of the issue, present a mixed picture: Three winners and two losers; one positive surprise and three negative shockers.

The company reports a small return on equity of 1% with a high level of debt amounting to 92% of equity.

Institutions own 24% of total shares -- the total includes DryShips' considerable holdings -- and the price has been bid up to where it takes $2.18 in shares to control a dollar in sales.

ORIG on average trades 999,000 shares a day, based on the past 10 days. However, volume has been inflated by the DryShips' share sale. A more reasonable average would be somewhere below 100,000.

That's insufficient to support option liquidity. Open interest is mainly in the single digits with a few double- and triple-digit strikes to add some spice. The bid/ask spread on the front-month at-the-money puts is 12.2%, a fairly crippling level.

Shares, it turns out, have an even greater 18.9% bid/ask spread, which is really unusual for shares.

At this point, I need go no further in my analysis.

Decision for my account: The option illiquidity means that options aren't an option (so to speak). It's a bear signal, and the only way to play it without options is to short shares.

ORIG shares can't be shorted. It's too small for that game. Plus, the stock bid/ask spread turns me away from the position; I'm just not willing to absorb that much overhead to make a trade.

There's no barrier in the chart to opening a position. The problem is all in the logistics of trading. And in my business as a trader, as in Ocean Rig's as a driller, logistics count.

References

My trading rules can be read here.  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.

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, February 20, 2013

ALV: Upside breakout in a triangle

Update: I closed my ALV bull position on March 25 as the price fell below the 10-day price channel lower boundary, $67.71. The loss on the position, which was constructed of long stocks, was 2.8%. The triangle pattern discussed in the original analysis remains active on the weekly chart.

Autoliv Inc. (ALV) broke above it's combined 20- and 55-day price channels on Tuesday, it's third test of the  $68.92 level. The move would be a bull signal if the stock trades above that breakout level on Wednesday.

This is the 36th breakout for ALV since January 2009. In that period breakouts have been evenly divided between upside and downside. The upside breakouts have had a 55.6% success rate for an average yield of 10.6%.

In the past year ALV has broken out three times to the upside and four times to the downside. The upside breakouts have succeeded twice.

The breakouts show a bias toward profit when the stock is rising that has increased the the last year from the average from 2009 onward.

ALV has been trending sideways since Jan. 2 after a rise from $54.72 on Nov. 16 to the breakout level on Jan. 3.

Today's breakout pushed to a high of $69.26.

Longer term, ALV appears to be tracing an ascending triangle, with a breakout point at $69.61, slightly above Tuesday's price-channel breakout.

I calculate the base of the triangle as $21.66 wide, which gives an upside target of $91.27 upon breakout.

That's all if you believe in triangles, of course. Me-- I'm not entirely convinced, because a triangle pattern is visible to all traders and so gets priced in before the pattern concludes. It seems--illogical.

ALV, based in Stockholm, Sweden, makes auto safety equipment, such as seatbelts, airbags and child safety seats. The company resulted from the merger of a Swedish and an American company. It has a global reach, with 80 facilities and employees in 29 countries.

It is also traded on a European exchange.

Analysts on balance dislike ALV's prospects, showing an enthusiasm rating of negative 60%.

On the books the company has a respectable return on equity at 13% and moderate debt, at just 15% of equity.

Earnings have been profitable for at least the last 12 quarters, with nine upside surprises and three to the downside. There's nothing in the earnings for that period that could be called a trend.

Institutions own 42% of shares and the price is low: It takes 80 cents in shares to control a dollar in sales.

ALV on average trades 515,000 shares a day. It has options, but the open interest is insufficient to meet my criteria. The bid/ask spread on the front-month at-the-money calls is a crippling 16%.

So the way I trade, it's shares or nothing when it comes to ALV.

We can, however, use the options in our analysis. Implied volatility on ALV stands at 32%, the result of a sharp rise on Tuesday.

I analyze stocks statistically using two standard deviations, which capture 68.2% of trades within the bounds.

Options are pricing in confidence that 68.2% of trades will fall between $62.73 and $75.63 in the next month, for a potential gain or loss of 9%, and between $66.08 and $72.28 over the next week.

Options were active to the bull side on Tuesday, with calls trading at nearly five times their five-day average volume.

Autoliv next publishes earnings on April 26. It goes ex-dividend in May for a quarterly payout yielding 2.89% based on current prices.

Decision for my account: I intend to open a long stock position in ALV on Wednesday if the issue trades above the breakout level, $68.92. The historical odds for success on upside breakouts are acceptable, and whatever the analysts may think, I see nothing poisonous in the company's financials.

References

My trading rules can be read here.  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.

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.

Saturday, February 16, 2013

The Week Ahead: Inflation, housing, much more

Monday is Presidents' Day, a market and government holiday in the United States, a fact that has squeezed almost every econ report of interest into Wednesday and Thursday.

There are a lot of interesting reports, and surely a few will move prices:

The two inflation reports -- producer prices at 8:30 a.m. Eastern on Wednesday and consumer prices at 8:30 a.m. on Thursday.

Two housing reports: Housing starts at 8:30 a.m. on Wednesday and existing home sales at 10 a.m. on Thursday.

Federal Open Market Committee minutes from the Jan. 30 meeting, at 2 p.m. on Wednesday.

The Philadelphia Federal Reserve  Bank's survey of  business conditions in the mid-Atlantic region, which gets a jump on the Institute of Supply Management's manufacturing index and the index of industrial production, at 10 a.m. Thursday.

Busy busy.

Leading indicators (in descending 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, at 4:30 p.m. Thursday.

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

Average weekly initial jobless claims, at 8:30 a.m. Thursday.

Building permits for new private homes from the housing starts report at 8:30 a.m. on Wednesday.

While not itself a leading indicator, the Conference Board's index of leading economic indicators will be released at 10 a.m. It is not itself considered to be a leading indicator because it, quite naturally, is released later than its leading components. I consider it to be a trailing leading indicator.

Other reports of interest:

Tuesday: The Home Builders' housing market index at 10 a.m.

Thursday: The Purchasing Managers' manufacturing index flash just before 9 a.m. and petroleum inventories at 11 a.m.

I also follow the Baltic dry index, released daily, tracking the volume of global maritime shipments of coal, iron ore, grain and other raw materials.

Fedsters

Two members of the Federal Open Market Committee have public appearances: St. Louis Fed Pres. James Bullard on Thursday and Fed Governor Jerome Powell on Friday.

An FOMC alternate, Dallas Fed Pres. Richard Fisher, makes an appearance on Thursday.

Trading calendar

By my rules, as of Tuesday I'm using March options for the short vertical spreads and May options for single calls and puts and the long vertical spreads. Of course, shares are good at any time.

Good trading!

Tuesday, February 12, 2013

TER: A bull breakout with notes of caution

Update: I closed the position on March 21 for a 6.6% loss.

Teradyne Inc. (TER) broke above its 20-day price channel on Tuesday, sending a bull signal less than a month after the company issued guidance that was below analyst expectations. However, there are reasons for caution: The breakout success rate has been weakening and options trading was in the doldrums on breakout day.

I'm posting this from Asia, after Tuesday's market close. At this point I don't know whether the breakout will be confirmed by trading beyond the price channel on Wednesday. I discuss placing an order before confirmation in the "Decision for my account" section at the end of this post.

The price has been stair-stepping upward from $13.54 on Oct. 15, and over the longer term from $10.37 in early October 2011. Key resistance points to the upside of Tuesday's close, $17.30, are $17.49, $18.01 and $19.19.

The upside breakout above the $17.29 boundary is fully consistent with the bullish cast of the chart, which lends credence to the signal.

Since January 2009, seven out of 10 breakouts to the upside have proven to be profitable, with an average yield of 9.6%. The profit, adjusted by the 70.6% success rate, produces a score of 6.8, which is high enough to satisfy my preferences.

However, TER's record of successful breakouts is weakening, which makes me somewhat skeptical about this breakout.

TER has broken beyond its price channel in both directions 38 times since January 2009.

The most recent breakouts have had a lower rate of success than in past periods, with the successes equally distributed between upside and downside breakouts.

The analyst consensus regarding Teradyne is positive, with a 42% enthusiasm rating. And Teradyne's finances support that opinion.

Headquartered in North Reading, Masschusetts, Teradyne makes automated systems to test electronics, serving such customers as Samsung, Qalcomm and Intel.

It reports return on equity of 20% with very low debt amounting to just 10% of equity. Those figures put TER in growth-stock territory by my criteria.

Looking at the last 12 quarters, Teradyne has shown profits with peaks in the 2nd and 3rd quarters. The company's earnings have surprised to the upside in all 12 quarters.

Institutions own nearly all of TER's shares. The price has been bid up so that it takes $1.95 in shares to control a dollar in sales.

TER on average trades 3.1 million shares a day, sufficient to support a moderate selection of options strike prices with open interest running at two and three figures in the front month and up to four figures further out.

The bid/ask spread on front-month at-the-money calls is quite wide, running at 15%.

Based on options trading, TER has a moderate volatility, running at 26%, near the lower end of the six-month range. Volatility has been trending sideways since late January.

In measuring volatility and pricing I set boundaries using two standard deviations, a statistical calculation of the boundaries that include 68.2% of a total.

Options are pricing in confidence that 68.2% of trades over the next month will fall between $15.98 and $18.62, for a potential gain or loss of 7.6%.

The breakout fell far short of sparking a trading frenzy. Options were trading sluggishly on Tuesday, with calls at only 21% of the five-day average volume and puts at a mere 4%. Stock volume remained comparatively low, at the levels seen the last three days of trading.

The fair-price zone on today's 30-minute chart runs from $17.25 to $17.36, encompassing 68.2% transactions surrounding the most-traded price, $17.31. At Tuesday's close TER was trading near the most-traded price.

An open above $17.36 on Wednesday would argue for continuation of the near-term bull trend. An open below $17.25 would argue against the bull trend.

Teradyne next publishes earnings on April 22.

Decision for my account: I'm trading from Asia for much of February. The time difference with New York means I must place my trades while the market is closed for execution the next day.

I've entered an order to open a bull position on TER, structuring it as a bull put vertical spread expiring in March, short the $17 puts and long the $15 puts.

This structure is profitable down to $16.63, giving me a 4% cushion in the event the price moves against my position. If the price continues to rise, I'll add to the position by buying call options expiring in July with deltas as close to 70 as I can find.

I've placed the order as a conditional trade: The order will go in 45 minutes after the market open, and it will be executed only if the price is beyond the breakout level, $17.29, confirming the breakout.

References

My trading rules can be read here.  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.

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.

LEN update

In my posting on Monday I  analyzed Lennar Corp. (LEN) and in the end decided to open a bear position. The stock the next day did a classic head fake and rose 4%.

This is every trader's nightmare, the reason we believe, our heart of hearts, that the market has a mind and will of its own, and it's out to get us.

How to deal?

First of all, my position is still profitable. Where liquid options are available, I structure my opening position as a vertical spread that gives me cushion in case of a reversal.

In the bear call spread I opened on LEN, the position is profitable up to $41.63, a 5.2% cushion. Tuesday's high was $41.63, still in the profitable range, and the price moved down a bit at the end of the trading day.

Another way to deal is to not open the position until after the first half hour of trading, which gives the stock time to establish it's trend for the day.

I'm trading from Asia this month, so all of my orders are placed before the markets open.

My rule is that a position can be opened only if its trading beyond its 20-day price channel. LEN opened beyond the channel on Tuesday, and that's when my order was filled. The reversal came after my order had been placed.

As it turns out, my broker, TD Ameritrade, on its ThinkOrSwim platform allows me to place conditional options orders based on the price of the underlying stock that are submitted to the markets at a specific time.

I didn't avail myself of that facility in the case of my LEN trade. Had I done so, the order would never have reached the markets and I would have avoided the head fake.

As it is, Tuesday's rise to $41.55 failed to set a higher high. To do that it would need to top $43.22. By classic trend analysis, LEN remains in a near-term downtrend.

The price did hit a stop/loss point but moved away before I could close the position, negating the close signal. So I still consider LEN to be a viable position for my account at this point.

I would change my opinion if the price were to move persistantly above the stop/loss point, which is presently at $41.54.

References

My trading rules can be read here.  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.

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, February 11, 2013

LEN: Bearish breakout on a bullish chart

Update: LEN crossed above the upper 10-day price channel at $40.59 on March 5, ending the bear position with a 5% loss. 

Lennar Corp. (LEN) broke below its 20-day price channel on Monday on the 11th day of a decline from a peak of $43.22. If the stock trades below the channel boundary, $39.46, on Tuesday, the bear signal will be confirmed.

The bear signal runs counter to the  overall bullish cast that characterizes LEN's chart.

LEN has been stair-stepping upward since Nov. 15. The present decline has pushed the price below the  swing low of the most recent step in the rise.

The current retracement from a high is a hook at the top of a long-term price increase that began from $12.14 in the fall of 2011.

History suggests that LEN may be been topping for much of this year.

Before this week, LEN has altogether broken beyond the price channel 32 times. The most recent breakouts have all been successful -- meaning profitable -- both to the upside and the downside. In earlier periods, success tended to be skewed toward the upside breakouts.

It's a pattern that suggests a strengthening of the downward movements.

Analysts, perhaps being fearful of being caught in a share distribution at the end of a long run -- no one wants to be the last sucker in line for shares -- have opinions that collectively give LEN a 29% negative enthusiasm rating.

That flies in the face of the chart. It also flies in the face of home builder and financial service company's business.

For the housing sector has begun to recover from the shock it received when its bubble collapsed. Based on the story as well as the chart, LEN by rights ought to be embarking on a period of growth.

Lennar Corp., based in Miami, Florida, has a moderately bullish financial spectrum, with return on equity of 7% but with a high load of debt, identical to equity, that is characteristic of the homebuilding industry.

Earnings have accelerated steadily from the 1st quarter of 2012 (adjusting for a one-time extraordinary gain in the 2nd quarter). Of the last 12 quarters, 11 have been profitable and 11 have showed upside earnings surprises.

Institutional ownership is quite high, amounting to nearly all of the shares, and the price has been bid up to where it takes $1.80 in shares to control a dollar in sales. Both show a degree of confidence in Lennar's business prospects.

Lennar's stock is quite liquid, making it easy to structure the full spectrum of options trades.

LEN on average trades 3.6 million shares a day, sufficient to support a moderate selection of option strike prices with front-month open interest running mainly to the three figures. The front-month at the money puts have a bid/ask spread of 3.1%, which is on the low side.

Implied volatility stands at 32%, near the lower end of the six-month range. Volatility has been on a gentle rise since late January.

Options are pricing in confidence that 68.2% of trades will fall between $35.69 and $42.85 over the next month. The range implied by options volatility would keep the price retracement below the swing high of $43.22.

In the near term there is little speculative pressure on LEN. Monday's options trading was running the five-day average volume, at 69% of average for calls and 44% for puts.

Monday's 30-minute chart buttresses the bearish case. It shows a fair-price zone from $39.21 to $39.85, encompassing 68.2% of transactions surrounding the most-traded price, $39.36. The stock closed near the bottom of the zone after falling for much of the day.

An open on Tuesday below the zone's lower boundary, $39.21, would strengthen the bear case.

Lennar next publishes earnings on March 28. The stock goes ex-dividend in April for a quarterly payout yielding 0.41% annualized at today's prices.

Decision for my account: I'm traveling in Asia and so, because of the time difference with New York, am placing trades when the market is closed. 

I've placed a conditional trade to open a bear position in LEN if it trades below it's $39.46 breakout level, structuring it as a bear call spread expiring in March, short the $41 calls and long the $45 calls.

The vertical spread reamains profitable up to $41.63, giving me a 5.2% cushion in the event the price moves against my position. If the price continues to fall, I'll add to the position by buying long puts expiring in May with deltas as near to 70 as I can manage.

References

My trading rules can be read here.  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.

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.

Friday, February 8, 2013

The Week Ahead: Industry and retail

Retail sales and industrial production are the main drivers of the week in economic reports. Together they cover the spectrum of what's necessary for the economic recovery to continue.

The government's retail sales report, the product of a survey by the Census Bureau, will be published Wednesday at 8:30 a.m. Eastern. No one goes blind into this report  -- sales by the major chains are released separately and on a more timely schedule -- but nothing can match the government's survey for comprehensiveness.

Retail sales are the mouth of the economic river. If people don't step up to buy, nothing the retailers and manufacturers do will matter.

Far upstream are the companies and people who make things, and that's tracked by the Federal Reserve's industrial production report, published Friday at 9:15 a.m. In some ways this can be seen a the industrial sector's opinion of consumer confidence within their respective sectors.

An old proverb says, "If you build it they will come". The industrial production report has quite the opposite premise: If you think they will come, you will build it.

Also, this is options expiration week. February options trade for the last time on Friday and expire on Saturday.

Leading indicators (in descending 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, at 4:30 p.m. Thursday.

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

Average weekly initial jobless claims, at 8:30 a.m. Thursday.

The index of consumer expectations from the Reuters/University of Michigan consumer sentiment report, out Friday at 9:55 a.m.

Other reports of interest:

Monday: The Treasury budget at 2 p.m.

Tuesday: Import and export prices at 8:30 a.m., business inventories at 10 a.m. and petroleum inventories at 10:30 a.m.

Friday: The Fed's Empire State manufacturing survey of business conditions in New York at 8:30 a.m. and Treasury's international capital report tracking the flow of foreign funds into and out of the United States, at 9 a.m.

Fedsters

Two members of the Federal Open Market Committee have public appearances: Kansas City Fed Pres. Esther George on Tuesday and St. Louis Fed Pres. James Bullard on Wednesday and Thursday.

An FOMC alternate, Cleveland Fed Pres. Sandra Pianalto, makes an appearance on Tuesday.

Trading calendar

By my rules, as of Monday I'm using March options for the short vertical spreads and May options for single calls and puts and the long vertical spreads. Of course, shares are good at any time.

Good trading!

Wednesday, February 6, 2013

On the road....

I'll be traveling in East Asia for several weeks beginning Thursday. Rather than adopting uncivilized hours of sleep to accommodate the time difference, I'll be adjusting my schedule to post overnight U.S. time, which is broad daylight in Asia.

The downside of the schedule is that I'll have no way of knowing whether a breakout was confirmed at the time that I'll post, and I'll note that fact in each post.

STRT: A bullish whipsaw

Strattec Security Corp. (STRT) broke above its 20-day price channel on Tuesday, culminating a three day run that carried the price up 20%. The breakout beyond the $29.96 channel boundary was confirmed today as the price moved still higher, to $31.51.

STRT has been in an uptrend since last September. This week's rise is the "saw" side of a seven-day bullish whipsaw that began Jan. 25 after the company exceeded earnings estimates by 18%. The stock immediately tanked. Go figure!

The entire move, both the collapse and the subsequent recovery, was accompanied  by higher than normal volume.

This is STRT's 11th breakout to the upside since January 2009, when my database begins. Its bullish breakouts have been profitable three times out of five, with an average gain of 22.3%.

Adjusting the 60% success rate by the average yield produces a score of 13.4%, which is quite high.

The last three upside breakouts, all in 2012, were successful, with returns of 1.6%, 3.9% and a whopping 22.2%.

Strattec, headquartered in Milwaukee, Wisconsin, makes locks and keys for automobiles and other applications. It sells not only in North America but also Europe, East Asia and South America.

The company has been in business for more than a century, either independently or as a division of Briggs & Stratton (BGG).

Strattec reports return on equity of 12%, a respectable level, with no long-term debt to speak of. Year-over-year quarterly earnings have consistently shown higher levels, especially the 2nd quarter (STRT's fiscal 4th quarter), when earnings are at their highest each year.

Earnings have surprised to the upside in seven of the last 12 quarters, and to the downside in five. All of the quarters were profitable.

Institutions own 74% of shares and the price is quite cheap in comparison with sales. It takes only 35 cents in shares to control a dollar in sales.

STRT is a thinly traded stock, with average volume running about 17,000 shares a day. Unsurprisingly, given the low liquidity, there are no options offered.

On average, the daily trading range runs about 3% of the share price.

The fair-price zone on today's 30-minute chart runs from $31.03 to $31.39, encompassing 68.2% of transactions surrounding the most-traded prie, $31.24. With 4-1/2 hours left in the trading day, STRT has mainly been floating slightly above the most-traded price and has stayed within a fairly narrow range.

Strattec next publishes earnings on April 25. The stock goes ex-dividend in March for a quarterly payout yielding 1.28% annualized at the today's prices.

Decision for my account: I've opened a bull position on STRT, structuring it as long shares. The breakout pushed the price decisively above near-term resistance, to a higher high. Also, the financials look good and the company is stable -- it has been around for awhile and lacks the failure risk common in young start-ups.

References

My trading rules can be read here.  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.

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, February 4, 2013

CACH: Small stocks bring big problems to traders

Caché Inc. (CACH) broke above its 20-day price channel on Friday and continued up that day through the 55-day channel.

There was no obvious news about Caché to explain the stock's 24% rise.

CACH was the best prospect left standing from my analysis of 4,343 stocks and exchange-traded funds tracked by the stock-rating company Zacks. And it removed itself from consideration in the first half hour of trading today by dropping below the breakout level, $2.79, creating a non-confirmation.

So this will not be a trading day for me. But even so, CACH is a good starting point to talk about position sizing, and why low share-price less-liquid stocks can create problems for traders.

CACH bubbled to the top like this: After excluding stocks near or just past an earnings announcement, I was left with a handful of fairly low volume issues. Low volume means low liquidity means no options or at best a poor selection with low open interest, and sometimes wider bid/ask spreads.

The price peaked on Friday at $2.97 before dropping back.

Position sizing is the practice of figuring out how much money to commit to each trade. Some people set a simple dollar figure. I prefer to base my dollar figure on my total trading funds, and then to adjust it for the volatility of the stock.

I begin by defining a unit -- the base size of the opening position in a trade. Under my rules, the unit is 1% of my trading funds. 

There's a lot going on in that short statement. "Base" means before I've adjusted for volatility. I specify that the unit is the size of the opening position in a trade because as a trend continues, I will add to it, each time committing an adjusted unit.

My limit for any one position, after adding to it, is four units.

I use the average true range, or ATR, to make the adjustment. The ATR measures the average daily movement, from the day's low to high or, if the prior day's close was outside the day's range, from that close to the day's low or high, depending upon whether the close is above or below the range.

The calculation is completed by averaging the ATR over a number of days. I average over 20 days, to match the 20-day price channel that I use in my analysis.

The Wikipedia article gives the formula.

This method isn't original to me, by the way. It was a mainstay of the original Turtle Trading method. This Investopedia article gives a rundown of the method, and this pdf file explains the Turtle Trading rules in detail.

To adjust for volatility, I divide the unit by the average true range. If the ATR is 1, then the unit and the adjusted unit will be identical. If the ATR is greater than 1, the adjusted unit will be smaller than the unadjusted, and if less than 1, the adjusted unit will be larger.

Low share prices produce small ATRs, because it doesn't take much of a price change to produce a significant percentage change.

CACH today has an ATR of 0.186 (18.6 cents), or 6.3% of the breakout point. That's fairly volatile, considering that the S&P 500 exchange-funded fund SPY has an ATR of 1.0076, amounting to 0.7% of the price.

So, let's assume a unit of $500, which would imply trading funds of $50,000. It's a fairly good sum, but not out of reach of many private traders. (That's not my unit size, by the way. I'm keeping that private.)

If I were buying SPY, then my adjusted unit would be barely changed from the base: Only $496.23.

CACH, however, is a different story.

If I divide the $500 base by the CACH average true range, 0.186, it gives me an adjusted unit size of $2,688.

The low price of CACH produces an unintended consequence: The more volatile stock has a far larger base. 

Generally, that's not a problem. A $80 stock is only four times the price of a $20 stock. But CACH is only 1/7th of the $20 stock and about 1/30th of the $80 stock. That bigger difference matters.

My present tactic has been to not adjust for low-priced stocks and just to buy a round lot, 100 shares, which adds slightly to the liquidity, and to count it by however many unadjusted units that comes out to.

There must be a better way, but I haven't worked it out yet.

The second problem is that a large unit for a low priced low volume stock means that I'm buying a lot of shares, possibly with insufficient liquidity to support it.

For example, a $500 unadjusted unit would mean the purchase of 179 shares of stock, probably rounded up to 200 shares for two round lots. 

The average volume of CACH is 39,684 shares a day. So that amounts to buying half a percentage of total volume. That's the equivalent of buying more than 61,000 shares of SPY.

Adjusting the unit according to the Turtle Trading rules implies the purchase of 900 shares of CACH, equivalent to 2-1/4% of the average daily volume. I can buy up to four units under my rules, so I could end up trading 9% of average volume.

It will be difficult to get good fills on CACH, or any other small stock, when placing orders of that magnitude.

Even worse, if the trade goes sour, it might be impossible to sell my shares at any reasonable price. I'd be stuck, like the last person standing in a game of musical chairs.

My purpose in this posting has been to point out problems, not to propose solutions. The analytical engine I built in software enables me to consider many more stocks than I could before. I gives me the power to reach beyond the mega- and large-cap stocks into the less liquid issue.

The problems I've discussed here call into question whether it's wise to use the power to expand my trading universe. I'll be looking at the issues over the next weeks and months, and will share my conclusion in this venue.

Please feel free to offer your thoughts on the subject  by posting a comment.

References

My trading rules can be read here.  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.

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, February 3, 2013

The Week Ahead: Factory orders, international trade

Twenty-five minutes before Super Bowl kick-off. I'll need to work fast.

And luckily, this week to come is as sparse in events as last week was crowded.

The economic schedule is sandwiched between factory orders on Monday at 10 a.m. Eastern and international trade on Friday at 8:30 a.m. There's not a lot of meat in between.

Leading indicators (in descending 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, at 4:30 p.m. Thursday.

Manufacturers' new orders for consumer goods from the factory orders report at 10 a.m. Monday.

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

Average weekly initial jobless claims, at 8:30 a.m. Thursday.

Manufacturers' new orders for nondefense capital goods from factory orders at 10 a.m. Friday.

Other reports of interest:

Tuesday: the Institute of Supply Management non-manufacturing index at 10 a.m.

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

Thursday: Productivity and costs at 8:30 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'm using March options for the short vertical spreads, iron condors, and the short legs of calendar, diagonal and butterfly spreads and covered calls, and May options for single calls and putslong vertical spreads, iron condors and the long legs of calendar, diagonal and butterfly spreads. Of course, shares are good at any time.

Good trading!

Friday, February 1, 2013

GD: An impressive head fake


General Dynamics (GD)  soared after a downside earnings surprise, but traders who jumped on the band-wagon were in a for shock as the stock delivered a truly impressive head fake.

GD broke below its 20-day price channel on Thursday, negating 6.7% one-day gain following an earnings announcement a week earlier, on Jan. 23. The decline through the channel's lower boundary, $67.20, pierced a higher low set on Jan. 2 as GD's price stairstepped to a swing high of $72.01 on  Jan. 7.

Adding to the confusion is that the earnings missed the analysts forecasts by 35%, speaking volumes about the value of earnings forecasts and the rationality of markets.

The less nimble traders who played the jump after earnings no doubt saw the relatively slight decline the next day as a correction of market exuuberance, confirmed the day after by a rise, although with a lower high, and then with an increasing feeling of dread as the stock dropped day after day at an accelerating rate.

If there were a National Head-Fake Museum, this one would deserve a prominent display.

The next downside resistance on the chart is at $61.70, a lower low established on Nov. 16.

GD since January 2009 has been profitable in seven out of 10 breakouts to the downside. The average profit on successful trades, however, has been only 5.1%.

This bumps against a standard that I've been applying to my trading, because adjusting the average profit by the 66.7% success rates gives a score of 3.4%. My practice has been to reject trades that score below 5%.

Note, however, that I called it a practice, not a rule. A difference is that I don't break rules (hardly ever), but I'm willing to adjust practices to the circumstances.

My circumstance now is that we're in earnings season, and it's hard to find trades because of my rule against trading within 30 days before an earnings announcement. So my choice, some days, is to not trade or adjust a practice. That's what GD would require.

(See my essay "On the virtue of being slacker" for a discussion of how earnings seasons impacts my trading rules.)

This is GD's 16th breakout to the downside since 2009, when my database begins.

A deeper analysis shows that GD's success rate has been increasing.

I divided the 15 prior breakouts into quintiles of three apiece, with the most recent quintile being the 1st and the earliest being the 5th.

The odds of success were only 1:3 in the earliest quintile in 2009. It was 3:3 in the most recent quintile, in 2012.

The average profit for winning trades peaked at 10.1% in the 4th quintile, in 2010, and is only 4.3% in the most recent quintile.

Another approach is to calculate the average return of all breakouts in a quintile, whether they made money or not. The profits from successful trades in the first three quintiles were wiped out by large losses from failed trades, so each showed a negative yield.

That picture has changed in the two most recent quintiles, each of which showed an average profit from all breakouts.

Given that trend, I'm willing to bend my practice in favor of a trade on GD -- if I like the rest of the analysis.

General Dynamics, headquartered in the Washington, D.C. suburbs, is a major player in the U.S. defense industry, and in fact is the fourth-largest defense contractor in the world. Anyone into fighting systems will find it pleasant to browse through the company's website, which is an education into what is state-of-the-art in the world of war.

Brokerage analysts, collectively, show a 36% enthusiasm rate for GD. It's important to remember that these folks, actually, are a trailing leading indicator. What their published forecasts are now is what they were saying before the most recent earnings announcement, and so they doesn't reflect that negative surprise.

Far more to the point is the company's 18% return on equity with debt that's not too awful, at 34% of equity.

Looking at the last 12 quarters, the company has never failed to show a profit. The last two quarters have shown declines from both the prior quarter and the year before.

Nine of the last 12 quarters has shown an upside earnings surprise, and three have surprised to the downside. The three downside surprises came in the last four quarters.

So General Dynamics' earnings have been stumbling a bit, which is certainly enough to make any longer-term trader a bit nervous.

Institutions own 74% of shares, and the price is low. It takes just 74 cents in shares to control a dollar in sales. Sometimes prices are low for a reason, and in this case the low stock price in terms of sales is a serious divergence from the analysts' happy talk.

GD on average trades 3.9 million shares a today and supports a fair selection of options stike prices with open interest running to three figures around the money. The bid/ask spread on front-month, at-the-money puts is 8%, a bit out of the narrow range.

It's not a very volatile stock.

Implied volatility, based on options trading, is running at 20%, slightly below the middle of the six-month range. It had been rising since late January into Thursday, but it declined today.

Options are pricing in confidence that 68.2% of trades will fall between $62.34 and $70.04 over the next month, for a potential gain or loss of 5.8%, and between $64.34 and $68.04 over the next week.

Nearer term, there are signs of speculative fever in GD, on both sides of the equation.

Options are trading at more than double their five-day average volume, 226% for calls and 278% for puts.

Today's trading buttresses the bearish case.

The fair-trade zone on today's 30-minute chart runs from $66.20 to $66.68, encompassing 68.2% of trades surrounding the most-traded price, $66.32. With a bit more three hours left in the trading day, GD is trading below the lower bound of the zone.

General Dynamics next publishes earnings on April 24. The stock goes ex-dividend in March for a quarterly payout yielding 3.08% annualized at today's prices.

Decision for my account: These points argue in favor of a GD trade: The increasing success rate of downside breakouts, the truly tricky head fake to the downside and the fact that GD is trading below the fair price zone. The low price of the stock, suggesting a lack of confidence in the future, also helps make the bear case. The bullish financials argue against a trade, although they mainly are of interest to longer term traders.

I opened a bearish position today on GD, structuring the initial position as a bear call spread expiring in march, short the $67.50 call and short $70 call. This gives a potential maximum yield of 41%. The spread is profitable down to $68.23, providing a 3% cushion in the event the stock rises.

If the price continues to fall, I'll add to my position by buying long puts expring in May.

References

My trading rules can be read here.  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.

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.