The position was structured as short vertical option spreads sold for a premium. The options' yield on risk was negative 50% -- a loss.
A Pharmacyclics Inc. (PCYC) bull signal broke above a six-week sideways trend that corrects from the latest peak in an uptrend that began in 2009. However, the price remains short of the highest high, $95.85, set March 6. Although the uptrend remains in place, so does the correction, until the price exceeds that high.
The most recent leg up began Nov. 7, 2012 from $44.91. The price more than doubled between that point and the peak. The correction carried down to a low of $71.85 on April 15. The bull signal was produced when the price broke beyond the 20-day price channel's upper boundary, $84.67.
The largest correction of the uptrend ended in early March 2011 at $4.75, which seems long ago and far away when compared to current price levels.
This is PCYC's fourth bull signal since the present leg up began. Two were profitable, for an average yield of 12.2%, compared to a loss of 9.4% for the unprofitable trade. in the period since the 2011 correction the 10 signals broke evenly between winning and losing, but with a far higher yield spread: An average profit of 54.1% for the winners vs. an average loss of 8.9% for the losers.
And even going back to 2009, when the broad markets began recovering from the post-recession crash, PCYC has shown strong momentum to the upside. Eight of the 15 completed bull signals were profitable, for an average yield of 66.5%, compared to a loss of 7.7% for the unprofitable signals.
The question any trader asks when looking at a chart like PCYC's is whether the train has left the station, the ship has left the dock, the profits have all been made, and the price is about to tank.
Those questions all assume that the market has a memory, and I agree that it does. They also assume that the market has a long-term memory stretching back five years that can be traced, like an EEG, on a simple candlestick chart. Of that, in the high velocity year 2013, when trading horizons are measured in milliseocnds, I'm not so sure. I think it's likely that the market's memory is far more complex.
The wisdom of jumping in during a long uptrend is certainly worth questioning, but it's not ipso facto a deal killer.
Pharmacyclics is a Sunnyvale, California biopharmaceutical development company focusing on small-molecule enzyme inhibitors, something that I have zero understanding of. For me, at least, this company would fail the Warren Buffett test of being able to describe in a sentence or two what a company does.
Analysts, who presumably have more understanding than I do, are less than happy about PCYC's prospects. They give it a negative 18% enthusiasm rating.
The company's financials are quite respectable, with return on equity of 18.7% and no long-term debt.
Earnings are spotty, as I would expect from a drug development company. It has lost money in nine of the last 12 quarters, the biggest loss occurring in the most recent, the 1st quarter of 2013. It has made money in three of the 12 quarters .
The company has surprised to the upside and the downside six times each.
Institutions own 70% of shares, and the price has bid up to a ridiculously hopeful level. It takes $37.78 in shares to control a dollar of sales. Again, it's a development company, and the prices are based on the big payoff that, investors hope, lies ahead.
PCYC on average trades 730,000 shares a day and supports a remarkably good selection of option strike prices for a stock at that level of liquidity. Open interest runs to three figures, and the front-month at-the-money bid/ask spread on calls is 6.2%.
Implied volatility is quite high, at 64%. It stands slightly above the mid-point of the six-month range.
Options are pricing in confidence that 68.2% of trades will fall betweek $71.63 and $104.27 over the next month, for a potential gain or loss of 18.6%, and between $80.11 and $95.79 over the next week. That's the sort of opportunity and risk that high volatility buys.
Calls have an edge in current trading, running at 55% above the five-day average volume, compared to 53% for puts.
The fair-price zone on today's 30-minute chart runs from $85.67 to $87.74, encompassing 68.2% of trades surrounding the most-traded price, $87.06. The stock opened this morning below the most-traded price but in the last two hours, with 2-1/2 hours before the closing bell, has moved above the fair-price zone.
Pharmacyclics next publishes earnings on Sept. 6.
Decision for my account: I opened bull position in PCYC, structuring it as a vertical credit spread of options expiring in June, short the $85 put and long the $80 put. The position provides a 5.6% cushion between the entry price and the breakeven point, and the potential maximum yield at expiration is 25.9%
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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