Thursday, March 21, 2013

MPEL: Bull play on Macau casinos

Update: I closed my bull position in MPEL on April 8, based on the close signal given on April 5. This is an example of a tactical close -- rather than closing immediately upon the signal, I waited, gambling that I could get a better deal after the weekend.

And so it proved. I closed the positions at $22.66 on the underlying stock for a profit of 0.7%. My position was structured as short vertical options spreads. They sold for a 63.6% profit. (Had a closed immediately upon the signal, the options result would have been a loss of similar proportion.)

Update: MPEL on April 5 gave a signal to exit my bull position as the price cross below the 10-day price channel at $21.49. 

My position is structured entirely as short vertical option spreads whose last day of trading is April 19. If the price is above the breakeven point, they options make money the closer they get to expiration. 

So rather than exiting immediately, I'm taking a more strategic approach in the hope of trading time for profit. The trade will be profitable if the options expire with the stock price above $21.75

Looking solely at the underlying stock, the exit signal came 1.5% below my initial entry. I added to the position three times, and the exit signal is 4.5% below the basis for the whole position.

Melco Crown Entertainment Ltd. (MPEL) moved above its 20- day price channels on Wednesday, its 16th bull signal since the broad markets began to recover in early 2009 from the post-recession crash.

MPEL has been in an uptrend since July 26, 2012, when it hit a low of $9.13.

Wednesday's move above the breakout level, $21.29, was confirmed today as the stock continued its rise, hitting a high of $22.24 in the first two hours of trading.

Since the present uptrend began, MPEL has sent three bull signals, two of them profitable with an average yield of 28.4%.

Nine of the 15 prior breakouts from early 2009 have been profitable, with an average gain of 26.4%. Adjusted the gain by the 60% success rate gives a score of 15.9%, triple my minimum preference.

A dozen stocks survived screening of Wednesday's breakouts. The three most liquid contenders LVS -- also a casino operator -- and the department store M.

I rejected LVS because the stock is in a sideways trend, and M had less than even odds of success in bullish breakouts since its current uptrend began. (See last night's post of Wednesday's breakouts for a list of stocks surviving my initial screens.)

Melco Crown Entertainment's casino and entertainment holdings are in Macau across the Pearl River from Hong Kong.

Analysts collectively love MPEL, giving it an enthusiasm index of 67%.

The company reports return on equity of 12%, which is below growth-stock territory, and has long-term debt that is higher than I like to see, amounting to 67% of equity.

Earnings the last three quarters of 2012 were below the corresponding quarters of 2011. Out of the last 12 quarters, the company has been profitable in all but two. The losses occurred back in 2010.

Melco Crown Entertainment earnings have surprised to the upside six times in 12 quarters, and five times to the downside.

Institutional ownership is quite low for such a liquid stock, at 28% of shares. The stock price is well above sales parity. It takes $2.78 in shares to control a dollar in sales.

MPEL on average trades 5.3 million shares a day, sufficient to give it an excellent selection of option strike prices with open interest mainly running to the five figures. The at-the-money front-month bid/ask spread on calls is quite narrow, at 3.3%.

In the following analysis I use the term "68.2%" in several places. It refers to the concept of a standard deviation in statistics. One standard deviation has boundaries that encompass 68.2% of whatever is being studied, such as opinions or stock trades.

MPEL's implied volatility, based on options trading, stands at 40%, near the bottom of the six-month range. It has been declining since mid-February.

Options are pricing in confidence that 68.2% of trades will fall between $19.32 and $24.36 over the next month, for a potential gain or loss of 11.6%, and between $20.63 and $23.05 over the next week.

Trading in options contracts today is running above the five-day average volume, with bearish puts leading at 154% above average, compared to calls at 37% above average.

The fair-price zone on today's 30-minute chart runs from $21.81 to $22.16, encompassing 68.2% of transactions surrounding the most traded price, $21.86.

The price quickly moved to the top of the zone in the first half hour of trading today, and then dropped back and in the third hour of trading was at the bottom of the zone, suggesting that momentum had stalled for the moment.

Melco Crown Entertainment next publishes earnings on May 6.

Decision for my account: There's nothing to dislike about the stock, its chart or the historical odds. The slowing momentum today are causes of concern for short-term trading.

I've opened a bull position on MPEL, structuring the initial position as a vertical spread for credit expiring in April, short the $21 put and long the $19 put. The position is profitable down to $20.55, providing a 6% cushion. The risk/reward ratio is 3:1, and the potential yield is up to 18.4%.

If the price continues to rise, I'll add to the position by buying long calls with deltas as close to 70 as I can manage.


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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