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.