I constructed the position out of short vertical option spreads, which I bought back for a 2.4% profit on risk.
Tesoro Corp. (TSO) has sent a bull signal, breaking above its 20-day price channel boundary, $55.97, on Monday and giving confirmation by continuing to trade above that level today. The breakout came on the third day of a run-up that followed publication of 1st quarter earnings, which beat analysts' expectations by 3%.
This is the third week of an uptrend retracing a correction within a larger uptrend that began from $21.94 in June 2012. The stock hit a high of $59.90 on March 25 before correcting down to $47.98 on Aprl 17.
A break above the $59.90 level would signal resumption of the larger uptrend. A failure to do so would leave the broader uptrend in place but still correcting. A drop below $47.98 would allow the possibility that a downtrend was beginning.
This is TSO's 5th bull signal since the present uptrend began. The four completed breakouts have split evenly, two profitable and two loss-making.
The winners, however, had an average yield of $38.7%, compared to an average loss of 5.2% for the unprofitable trades. The resulting is a truly stunning 33.5% win/loss yield spread.
TSO has done less well over the longer term, with 20 completed bull signals since early 2009, when the broad markets began recovering from the post-recession crash. Only six of those were successful, however, with an average yield of 26.8%. The 14 unsuccessful trades lost 6.2% on average.
The odds -- the success rate -- is a measure of momentum, and I give more weight to momentum during the current trend than to historical movements. So while the poor showing from 2009 onward raises a cautionary flag, the somewhat better performance in this trend, and especially the large win/loss spread, argue in favor of taking the trade.
Tesoro, headquartered in San Antonio, Texas, refines and markets petroleum products in its seven refineries. It sells fuel and convenience products through 1,175 retail stations in 18 states under the names Tesoro, Shell and USA Gasoline.
Analysts are positive about TSO's prospects, collectively giving it a 38% enthusiasm rating. The financials buttress their enthusiasm. Tesoro reports return on equity of 21% and debt equal to 31% of equity.
Earnings have been spotty over the last 12 quarters, with losses reported in two quarters, a 2011 uptrend in earnings ending in a losing quarter, and the beginning from the 3rd quarter of 2012 of a downtrend in earnings that has continued through the most recent report this month.
Eight quarters have surprised to the upside, and four to the downside.
Institutional ownership is high, at 91% of shares, and the price is in the bargain basement. It takes only 24 cents in shares to control a dollar in sales.
TSO on average trades 3.5 million shares a day, sufficient to support a wide selection of option strike prices with open interest running as high as five figures for some front-month strikes. The front-month at-the-money bid/as spread for calls is low, at 2.9%.
Implied volatility is running at 47%, above the mid-point of the six-month range, and has been tracing something resembling an ascending triangle -- even highs and rising lows -- since late April.
Options are pricing in confidence that 68.2% of trades will fall between $50.30 and $65.96 during the next month, for a potential gain or loss of 13.5%, and between $54.37 and $61.89 over the next week.
Update: TSO gave an exit signal by trading below the 10-day price channel, and I've exited the position for a profit. The share price declined 5.1% from initial entry. I added to the position three times after entry, and my share basis is 3% below entry. The position was constructed as short vertical option spreads, providing both hedging and leverage. The spreads yielded a profit of 9.1% on risk.
Trading is heavier on the put side, with volume running more than double its five-day average. Calls are trading at a bit more than half of average volume.
The fair-price zone on today's 30-day chart runs from $57.75 to $58.35, encompassing 68.2% of transactions surrounding the most-traded price, $58.03.
The price has been trading within the zone for the all of the session, with the exception of a few short-lived forays beyond the boundaries. With 2-1/2 hours to go before the closing bell, TSO is trading just above the fair price zone.
Tesoro next publishes earnings on April 2. The stock goes ex-dividend on May 29 for a quarterly payout yielding 1.38% at current prices.
Decison for my account: The main sticking point is the even odds of success for the current trend, and the large win/loss spread overcomes that objection in my mind.
I've opened a bull position in TSO, structuring it as vertical credit spread expiring in June, short the $55 put and long the $50 put. The position has a potential maximum gain at expiration of 21% and a cushion between the entry price and the expiration breakeven point of 8.4%. Excellent numbers!
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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