I structured the position as hedged and leveraged short vertical option spreads. They produced a negative 17.6% yield on risk.
NRG Energy Inc. (NRG), in breaking below its 20-day price channel, set a lower low, breaking a daily-chart uptrend that has been in effect since Oct. 15, when the price hit a correction low of $19.28.
The correction was part of a weekly chart uptrend that began from $14.29 in April 2012.
The prior low in the current leg up was $26.70 on May 10. On Tuesday NRG recorded a low of $25.73 and has traded still lower today.
However, one low does not a trend make. To confirm the trend, NRG will need to rise and then reverse at a level below the swing high of $28.67, set on May 22, and then push below whatever the final low will be in the present leg down.
That's not a barrier to opening a bear position now. It is something to keep in when determining where to get out -- a rise above $28.67 says the downtrend is over so head for the exit.
This is NRG's second bear signal since the present trend -- to the upside -- began in April 2012. The one completed trend was a success, yielding 6.3%.
NRG was one of six symbols to survive my initial screening (see "Wednesday's Prospects", posted last night). All but NRG and FBR retreated back within their price channels, failing to confirm the signal.
FBR sent a bull signal, but its options lack sufficient open interest to meet my criteria for trading, and at this point I'm looking for symbols I can both hedge and leverage using option credit spreads. That leaves NRG as the only symbol on today's list that will meet that need.
NRG Energy is a wholesale energy company with an operational headquarters in Houston, Texas. It also sells electricity to retail markets.
Analysts are quite positive about NRG's prospects, giving the stock a 63% enthusiasm rating. Of course, those opinions will date back to before the present price decline.
Utilities like NRG are assessed not only as energy providers but as dividend plays. Treasury yields rose on Tuesday, and utility stocks generally fell, since dividend yield rises produce a corresponding fall in the market price of principal.
I don't say that a higher yields account for everything that's happening with NRG, but it is most certainly a contributing factor.
NRG Energy is something way less than a growth stock. Return on equity is only 2%, and debt stands 56% above equity. These are good numbers for a bear play such as the one I'm contemplating.
The company since at least 2011 has produced losses in the 4th and following 1st quarters and profits in the rest. Losses for those quarters in the 2012/13 were less than the 2011/12 combo, which in turn were more than the prior year.
Profits in the two profitable quarters were a mirror image: Lower profits in 2010, higher in 2011 and lower in 2012. NRG Energy year by year has tended toward extremes in both directions.
Institutions own 96% of shares and the price is near parity with sales. It takes 98 cents in shares to control a dollar in sales.
NRG on average trades 4.1 million shares a day and supports a wide selection of option strike prices with open interest in four and five figures. The bid/ask spread on front-month at-the-money calls is 15.4%, quite a wide spread.
Implied volatility stands at 28%, above the mid-point of the six-month range. Volatility has been on a gentle rise since mid-May. Options are pricing in confidence that 68.2% of trades will fall between $23.87 and $28.01 over the next month, for a potential 8% gain or loss, and between $24.94 and $26.94 over the next week.
Options today are trading below their five-day average volume, at 54% of average for puts and 36% for calls.
The fair-price zone on today's 30-minute chart runs from $25.73 to $25.94, encompassing 68.2% of transactions surrounding the most-traded price, $25.90. With 90 minutes left before the closing bell, NRG is trading at the top of the zone after spending most of the day in the cellar.
NRG Energy next publishes earnings on Aug. 5. The stock goes ex-dividend in July for a quarterly payout yielding 1.85% annualized at current prices.
Decision for my account: I've opened a bear position in NRG, structuring it as a vertical credit spread expiring in June, short the $26 call and long the $28 call. The position provides a 2.2% hedge of profitability above the entry price and a maximum potential profit of 33.3%.
The wide bid/ask spread on options gave me some pause, and it was indeed impossible to get a fill at my initial asking price. The fact that this is an unproven downtrend within an uptrend is also reason for concern. In the end, however, I came down on the side of opening a position.
References
My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.
At several points in my analysis I use the number 68.2%. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.
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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