Monday, March 4, 2013

SYK: Buy on the sound of trumpets?

Stryker Corp. (SYK) broke above its 20-day and 55-day price channels Friday after making two announcements: A $25 million stock buy-back plan and completion of an acquisition that will expand its presence in China.

The move above the breakout level, $64.46, triggered a bull signal and broke above a sideways trend that has been in place since late January. The signal was confirmed today as the stock continued to trade above the breakout level.

At this point I'll insert my standard caveat on buying after the news is out, with my favorite cliche from the Napoleonic era financial Nathan Rothschild: "Buy to the sound of cannons, sell to the sound of trumpets."

Stryker's news releases are trumpets, so that sends up an immediate warning flag.

SYK's pattern since December 2011 has been to rise in fits and starts, in a series of quantum leaps. It moves suddenly, and then stays for a period within a sideways range. The gamble for me as a trader is whether Friday's breakout begins a leap to a new level.

Since the post-recession began in early 2009, SYK has broken above its price channel 15 times. Nine of those breakouts ended with a profit, for a success rate of 60%. The yield on the successful trades averaged 8.7%. Adjusting the yield by the success rate gives a score 5.2%, which meets my guidelines.

SYK has broken above the price channel six times since the the current quantum-leap pattern began in December 2011. Four were successful, for a 66.7% success rate, and the winners on average yield 5.1%.

Even longer term, SYK has been in a huge sideways pattern dating back to 2009, which major tests of the top at $64.61 and $65.21. Getting past those levels might be a chore, but they both date back to 2011, so perhaps not. Resistance, like cheese, gets stale and moldy after a time.

Stryker, headquartered in Kalamazoo, Michigan, develops and makes medical devices used in a wide range of surgery. Its products are sold in more than 100 countries and the company maintains 29 manufacturing and R&D locations.

Analysts in the aggregate are neutral on the company, with their opinions producing a negative 4% enthusiasm rating. That's a bit misleading, as averages always are. Half of the analysts following Stryker are hitting the buy-buy-buy button, and half are counseling traders to hold.

Stryker reports return on equity of 19% with moderate debt amounting 20 % of equity.

The company has been profitable for at least the last 12 quarters with a slight upward bias. Eight quarters have produced upside earnings surprises, and three have surprised to the downside.

Institutions own 66% of shares -- on the low side for a major company -- and the price has been bid up so that it takes $2.85 in shares to control a dollar in sales.

SYK on average trades 1.8 million shares a day and has a moderate selection of option strike prices with open interest running to the three and four figures.

The front-month at-the-money bid/ask spread for calls is 5.3%, which is on the low side.

Implied volatility is running at 18%, in the lower half of the six-month range and generally on the low side. It has been in a gentle uptrend since late January.

In my analysis below I use the the statistical device two standard deviations, a range is sufficient to include 68.2% of trades out of a larger universe.

Options are pricing in confidence that 68.2% of trades over the next month will fall between $61.36 and $68.22, for a potential gain or loss of 5.3%, and between $63.14 and $66.44 over the next week.

Speculation is leaning toward the bear side, with puts trading at their five-day average volume and calls at slightly above a third of the average.

The fair-price zone on today's 30-day chart runs from $64.74 and $64.93, encompassing 68.2% of transactions surrounding the most-traded pricde, $64.82.

SYK has traded within the zone after some volatility the first half hour of trading and at present, four hours before the close, is below the most-traded price.

Stryker next publishes earnings on April 24. The stock goes ex-dividend on March 26 for a quarterly payout yielding 1.64% annualized at current prices.

Decision for my account: One problem with low-volatility stocks like SYK is that they produce low yields. I would structure an initial position in the stock as a bull put spread expiring in April, short the $62.50 puts and long the $60 puts. This produces a potential 14% yield, which is not awful, but it comes at the cost of a 5:1 risk/reward ratio. 

I'm more comfortable with a 3:1 risk/reward ratio. For anything greater, I want a greater potential yield, and I'm not seeing that with SYK.

The chart is certainly playable, and I could overlook the buy-on-the-trumpets issue for enough potential gain.

The fact that the price isn't going anywhere today and the skewing of options speculation to the bear side raise cautionary flags.

It's a close call, but I'm passing on SYK. If the rewards were greater, I would be willing to open a bull position. But the rewards aren't, so I won't.


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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