SEP: Confused lemming

Update 7/16/2013: SEP reversed course on the 11th day of a sideways pattern and pierced the lower boundary of its 10-day price channel, giving an exit signal. My position was structured as long shares and I exited the day the signal was given for a 6.7% profit over an average holding period of 31 days. The annualized yield was 79.3%. 

Spectra Energy (SEP), in sending a bull signal, is confused lemming. While the crowd was, seemingly, preparing to rush for the exits, and as other energy stocks were already stumbling through the doorway, SEP calmly headed to the refreshments table for a cup of punch and a plate of pastries.

In this period of growing expectation that the Federal Reserve, to guard against inflation, may be preparing to close down the party, SEP's main attraction is that has correlated very poorly with the S&P 500 of late, and so seems to be an unlikely candidate to follow the other lemmings off the cliff. Although SEP one of the 500 stocks in the index, its 52-week correlation stands at negative 39 and has been falling since the start of April. (On the correlation scale, a 1 is moving in lockstep with the S&P 500 and -1 is moving exactly to the contrary.)

SEP's breakout came on the sixth day of a march to the upside that has carried the price to $41.09 (so far) its highest high of the past 20 years, eclipsing the prior high set on April 1. Today's high marked a way-station in a fairly steady rise from $27.15 in November 2012 up to  $40.08 last March, which was followed by a correction that hit bottom at $34.42 on June 4 before embarking on its rapid rise.

This is the second bull signal since the most recent leg up began last autumn. The one completed signal yielded 20.8% in a 70-day lifespan. Since the prior major low, in August 2011, the stock has completed five breakouts to the upside, all of them profitable, with a 4.1% average yield over an average lifespan of 38 days.

If I had no collateral information about the mood of the market and the state of the economy, my greatest concern about SEP would be that it had gone too far too fast. However, I've never found that to be an entirely persuasive argument. It seems like trying to guess how high up is; all I can do is point dumbly.

SEP was one of six symbols to survive my initial screening. (See "Thursday's Prospects" posted last night.)

Of the other bull breakouts, SCSS is in a downtrend, GBCI had unprofitable historical odds and PTNR had lower liquidity than SEP has.

Of the bear breakouts, MCP's near-term chart is arguably a correction with an uptrend (but it's ambiguous),  NFX has unprofitable odds and CCJ, while profitable, has shown low yields.

Spectra Energy, headquartered in Houston, Texas, transports natural gas, operating 3,200 miles of pipeline in the southeastern United States, in addition to storage facilities able to hold 57 billion cubic feet of gas.

The analysts following the stock are universally unenthusiastic about its prospects. Seriously so. Their enthusiasm rating stands at negative 100%.

That's hard to understand, given Spectra Energy's financials. The company reports return on equity of 12% with long-term debt amounting to 41% of equity. The debt is higher than I like but is far below crippling levels.

Looking at the last 12 quarters; Spectra has been profitable in each. The most profitable quarter, the 1st, has declined twice in this period from the year-ago quarter. Earnings have surprised to the upside seven times and to the downside, five.

Institutional ownership is quite low, at 29%, and the price is quite high, bid up to the point where it takes $18.43 to shares to control a dollar in sales.

Overall, Spectra's financials are a paradox: Analysts dislike it but the returns are good and the price stands at a level indicative of speculative excess. Here again, Spectra is running counter to the other lemmings.

SEP on average trades 259,000 shares a day, a level of liquidity that supports only a narrow selection of option strike prices and with low open interest. The front-month, at-the-money calls have a 23% bid/ask spread, which is quite wide.

I won't trade these options. The liquidity is low and the spread is way too high for my tastes. So if I open a position on SEP, it will be a shares. That costs me leverage and the chance to hedge the position.

But I'm having a difficult time finding trades in this environment, and while I'm always happy to not trade when the times aren't right, I'm more amenable to a shares deal if a decent options play isn't on the table.

Implied volatility stands at 21%, at the middle of the six-month rang. It has been zig-zagging lower for the past week. Options are pricing confidence that 68.2% of shares will fall between $38.49 and $43.49 over the next month, for a potential gain or loss of 6.1%, and between $39.79 and $42.19 over the next week.

Options trading is quite active today on both the upside and the down, with call running at 71% above their five-day average volume, and puts at 89% above volume.

The fair-price zone on today's 30-minute chart runs from $40.03 to $40.85, encompassing 68.2% of transactions surrounding the most-traded price, $40.43. SEP opened near the bottom of the zone, dropped below it in the first half hour of trading, and is trading above the zone with two hours to go before the closing bell.

Spectra next publishes earnings on July 29. The stock goes ex-dividend in August for a quarterly payout yielding 4.92% annualized at today's prices.

Decision for my account: I've opened a bull position in SEP, structuring it as long shares. My sizing rules are the same for shares as for option spreads -- I the unit size according to my trading rules, without any adjustment for the leverage shares lack compared to options.

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.