My analysis showed the risk increase to be about the same as the risk reduction at levels expected to encompass 68.2% of trades between now and expiration. With that in mind, I closed the position immediately rather than waiting to get out.
The exit was for a 0.8% loss on the price of the stock at initial entry. The position was added to three times during its lifespan, and so from my basis, the loss on the price of the stock was 3.1%.
For the options, the loss was 2.12% based on funds at risk.
Hewlett-Packard Co. (HPQ) on Thursday fell below its 20-day price channel. The bear signal was confirmed today as HPQ continued to trade below its $21.06 breakout level.
It was HPQ's 15th bear signal since early 2009, when the broad markets began recovering from the post-recession crash. Nine of the 14 prior breakouts to the downside produced a profit, with the yield averaging 9.3%. The five unsuccessful trades produced an average loss of 3.5%.
Applying the stock's success rate, 64.3%, to the average yield produces a score of 6%, slightly above the 5% minimum I prefer.
The downward move comes following a lower low in a downtrend that began in May 2010 from $54.75. After setting a lower high of $30 in February 2012, HPQ continued its fall, reversing from a lower low of $11.35 on Nov. 20, 2012.
The next lower high, the most recent, was $24.05 on April 1, and the reversal from that point set the conditions for the current bear signal.
There were no bear signals in the upward correction that ended April 1.
HPQ's bias is to the downside and has been for a long time.
The Palo Alto, California manufacturer of computers, printers and other tech products has long been a major player in the field. But the field has become crowded in recent years, and consumer preferences in computing are undergoing a tectonic shift that seems likely to kill off the desktop computer that has long been a mainstay of the industry.
The army of analysts that follow HPQ collectively give it a negative 87% enthusiasm index, this despite a 26.1% return on equity. The debt level may be one cause of angst. It stands at 93% of equity. The impact of high debt is to limit a company's options when the going gets tough.
Hewlett-Packard has been profitable for at least the lasts 11 quarters, although 2012 profit levels were consistently lower than those of 2011, and the 1st quarter of 2013 is below its companion quarter a year earlier. This is a clear case of decelerating earnings, a place no company in its right mind wants to be.
Institutions own 76% of shares,and the price has fallen to bargain basement levels. It takes only 34 cents in shares to control a dollar in sales.
HPQ on average trades 27 million shares a day and has an excellent selection of optoin strike prices with open interest running to the five figures. The bid/ask spread on front-month at-the-money puts is one cent, or 1%, as cheap as it gets.
Implied volatility stands at 34%, near the bottom of the six-month range. Volatility has been trenidng sideways since early March after a sharp February decline.
In the following analysis I'll use the term "68.2%" in several places. This is from statistics and signifies the percentage of things being analyzed that are contained in one standard deviation from a base.
Options are pricing in confidence that 68.2% of trades will fall between $18.76 and $22.78 over the next month, for a potential gain or loss of 9.7%, and between $19.80 and $21.74 over the next week.
Today's option trading is skewed toward the puts, which rare running 12% above their five-day average volume, compared to 47% below average for calls.
The fair-price zone on today's 30-minute chart runs from $20.73 to $20.87, encompassing 68.2% of transactions surrounding the most-traded price, $20.78. With four hours to go before the closoing bell, HPQ has been trading at more below the most-traded price for the past 90 minutes.
Hewlett-Packard next publishes earnings on May 21. The stock goes ex-dividend in June for a quarterly payout yielding 2.54% annualized at today's prices.
Decision for my account: I've opened a bear position in HPQ, structuring it as a short vertical spread expiring in May, short the $21 calls and long the $23 calls. This structure provides a 10.7% cushion above the entry price before the position becomes unprofitable. The maximum potential yield is 42%.
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.
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