Wednesday, March 27, 2013

VMED: Options complications tarnish a bull signal

Virgin Media Inc. (VMED) moved beyond its 20-day price channel on Tuesday and confirmed the bull signal on Wednesday by trading above the breakout level, $47.85.

The move continues a largely unbroken uptrend from $21.47 that has been in place since mid-June 2012. Today's high, $48.22 so far, places the stock in blue-sky territory, with no upside resistance.

It was VMED's 17th bull signal since the broad markets began to recover in early 2009 from the post-recession crash. Eleven of the 16 prior breakouts were profitable, with an average yield of 16.9%. The average loss of the five unsuccessful signals was 7%.

The strength of the uptrend is illustrated by the fact that there have been only two breakouts during its progress, both successful for an average yield of 34.7%.

A weaker uptrend would have more breakouts as the price zigged and zagged, generating bull signals and sell signals in rapid succession. With VMED, it has been all zig all the time.

Virgin Media is an Anglo-American entertainment and telecommunications empire whose operations are largely focused on the U.K. but whose headquarters is in New York. Shares are primarily traded on the NASDAQ, with a secondary listing in London.

It is in the process of being purchased by Liberty Global Inc. (LBTYA).

Perhaps it's a case of the stock having moved too far too fast, but analysts aren't enamored with VMED, collectively coming down with a 25% negative enthusiasm rating.

Profits have been accelerating at an incredible pace, from 16 cents per share in the 4th quarter of 2011 to 59.9 cents per share a year later.

Nine of the last 11 quarters have been profitable, and two shoed losses, the most recent being in Q3 of 2011. Earnings have surprised to the upside eight times, and to the downside, three times.

The accelerating earnings have pushed return on equity up to a ridiculous 150%, but with a very high level of debt amounting to 188% of equity.

Are those levels healthy and sustainable? If I were a long-term investor, I would be digging into the details of Virgin Media's financials to try to understand the depths of their situation. Being a technical trader, I shall simply note that the financials buttress the direction of the chart signal, and move on.

Institutions own nearly all of VMED's shares, and the price is high: It takes $2.08 in shares to control a dollar in sales.

VMED on average trades 6.4 million shares a day and has a moderate selecton of optoins with open interest running in the two- and three-figure range.

The front-month at-the-money bid/ask spread on calls is 22.4%, which is quite high for such as liquid stock.

Implied volatility stands at 17%, which is on the low side. Compare it to 13% for the S&P 500. Low volatility depresses the initial credit on short vertical option spreads, making it hard to construct a position with a decent return.

The volatility level is near the middle of VMED's six-month range and has been tracking sideways since mid-March.

In the analysis that follows I refer several times to "68.2%". This comes from statistics and the concept of one standard deviation, a set of boundaries that encompasses 68.2% of whatever is being analyzed, such as political opinions or stock prices.

Options are pricing in confidence that 68.2% of trades will fall between $45.77 and $50.57 over the next month, for a potential gain or loss of 5%, and between $47.02 and $49.32 over the next week.

Call options are trading at 96% above their five-day average volume, indicating a high degree of speculation. And it's all to the upside. Puts are trading at only 7% of average volume.

The fair-price zone on today's 30-minute chart runs from $47.62 to $47.98, encompassing 68.2% of trades surrounding the most-traded price, $47.92. In the 2nd hour of trading, VMED has moved above the zone.

Virgin Media next publishes earnings on April 24. The stock goes ex-dividend in June for a quarterly payout yielding 0.33% annualized at current prices.

Decision for my account: I'm passing on the trade because of the low volatility. I find it impossible to put together a vertical credit spread that will provide sufficient yield to cover my risk. The task is complicated by the fact that the near-the-money puts have low open interest, below 50 contracts. The high bid/ask spread is another complication.

It's possible to build a position out of shares or long calls (despite the wide bid/ask spread), but I prefer to direct my resources toward positions that provide both leverage and a hedge.

In addition, even though the company is a take-over target, there's still room to profit from its stock. Arguably, however, most of the risk is to the downside because of a chance that the deal could fall through.


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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