Thursday, March 28, 2013

LBTYA: An interesting play, lacking a hedge

Liberty Global Inc. (LBTYA) broke above its 20- and 55-day price channels on Wednesday and today confirmed the bull signal by trading above the breakout level, $71.83.

Liberty Global has been in an uptrend from $32.06 since early October 2011, with the most recent leg up having begun on Nov. 15, 2012 from $54.05. The price today has reached (so far) an all-time high of $73.46.

This stock is in blue-sky territory, with no upside resistance.

Prior to Wednesday's breakout, LBTYA has sent 17 bull signals, and 10 of them produced a profit, with an average yield of 16.9%. The seven unsuccessful trades lost, on average, 6.2%.

Adjusting the average profit by the 58.8% success rate produces a score of 10%, the highest among the three stocks listed in last night's posting as having survived my initial screens. LBTYA alone among the three confirmed Wednesday's signal.

The most recent leg up has produced two bull signals prior to Wednesday's breakout. One earned a 10% profit, and the other fell for a 3.6% loss. Two signals is insufficient to calculate meaningful odds of success.

Since the present uptrend began in October 2011, LBTYA has had six upside breakouts prior to this week, evenly split between profitable and losing trades. The yield on successful positions was 17.6%, and on unsuccessful position, a 3.2% average loss.

Generally, I prefer better than even odds on a trade, but a large average yield for winners compared to the losses suffered by losers can do a lot to make even a 50% chance of success look pretty good.

Liberty Global, headquartered in Englewood, Colorado, provides video, broadband internet and telephone services to 19.5 million customers, mainly in Europe and Chile. They are in the process of buying Virgin Media Inc. (VMED), company I rejected as a trade on Wednesday. (See my analysis here.)

LBTYA is followed by only a handful of analysts, who are unanimously enthusiastic about the company's prospects.

Liberty global reports return on equity of 7% -- OK but not exciting -- and a huge load of debt amounting to 13% equity, a result of a recent buying spree.

If I were a Warren Buffett style trader, I would look at the debt level and throw up my hands in dismay.  The question he would ask, of course, is whether that debt will result in earnings that can be used to grow the company.

It's a long-term question. I'm a short-term trader. So while I need to note the debt level as possibly pointing to a problem, it's not a trade killer in itself.

LBTYA's earnings have been all over the map, mainly in the badlands. It has reported losses in seven of the last 12 quarters, most recently the last quarter of 2012. The most recent profit was the 2nd quarter of 2012.

There has been no acceleration to the profitable or the losing side. The earnings pattern is fairly random. The profitable quarters have all surprised to the upside, and the losing quarters, to the downside.

Institutions own 94% of shares. It takes $1.75 in shares to control a dollar in sales.

LBTYA on average trades 2.6 million shares a day, sufficient to support a moderate selection of option strike prices spaced at $5 intervals.

Open interest runs in the three- and four-figure range. The front-month, at-the-money calls have a bid/ask spread of 5.7%, which is low for a stock of this degree of liquidity.

Implied volatility stands at 27%, just below the middle of the six-month range. It has been tracking mainly sideways since mid-March.

In the following discussion I use the term "68.2%" in several places. This comes from statistics, where one standard deviation -- a measure of confidence -- contains 68.2% of whatever is being studied, political opinions, for example, or stock trades.

Options are pricing in confidence that 68.2% of trades will fall between $67.35 and $78.89 over the next month, for a potential gain or loss of 8%, and between $70.35 and $75.89 over the next week.

There is a great deal of options speculation this morning, with calls trading at 17 times their five-month average volume, and puts at four times the average.

The fair-price zone runs from $71.55 to $73.44, encompassing 68.2% of transactions surrounding the most-traded price, $73.03. The stock is trading near the most-traded price two hours since the opening bell.

Liberty Global next publishes earnings on May 6.

Decision for my account: Aside from the longer-term financial concerns discussed above, there's nothing I actively hate about this stock.

However, I'm unable to put together an April vertical credit spread that will meet my needs. The only reasonable candidate is a bull put spread, short the $70 puts and long the $65 puts, which provides a 4.3% cushion against a fall the stock's price.

However, that produces a 9:1 risk/reward ratio, and I'm quite reluctant to ever go above 4:1.

Reasonable alternatives would be to go buy long calls, which are leveraged but lack a protective hedge, or shares, which lack both. Leverage is always important, of course, in order to earn a decent profit. And the hedge is especially important for trading a company engaged in a major purchase that might fall through.

So absent the ability to construct a hedged position, I won't be opening a bull position in LBTYA for my account.


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.

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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