SCSS: Bearish on beds

Update 8/26: SCSS broke above its stop/loss on Friday and confirmed the breakout today. I've closed the position for a loss.

SCSS was rolled once. The first position was profitable, and the second one was not.

Combined stats for the two positions: The stock rose by 3.7% over the 11 days I held the positions, which were structured as vertical options spreads sold for credit.

The options produced a negative 13.8% yield on risk, or negative 477.1% annualized.

Under my trading plan, I require a fresh breakout beyond the 20-day price channel before rolling a position. SCSS broke below the channel on Aug. 19. However, it reversed sharply the next day and triggered the stop/loss three days later.

Oddly, Jim Cramer in his Aug. 19 "Lightning Round" was bearish on SCSS. Cramer said, "There's nothing strong there. I'm not going to get behind this one. I just don't see a lot there to like."

The next day, the stock bumped up 4.5%, close to close. There must be a lot of Cramer Contrarians out there.

Update 7/25/2013: I've opened this position, as described in the "Decisions" section below. A slight change in the deltas put the leverage at 4.6% rather than 4.5%.

Select Comfort Corp. (SCSS) fell below its 20-day price channel on Wednesday. It was incorrectly listed as a Tuesday breakout because of a bad bar in my data.

The bear signal came in the form of an impressive 5% intra-day decline, to a low of $22.53. Further downside momentum on Thursday would count as confirmation, making SCSS eligible for a trade.

SCSS 2 years 2-day bar

The decline carried SCSS below its previous swing low of $22.78, set on June 24. That June swing low was followed by a rise to $27.84 on July 12 and a three day slide that turned into a rout following a 22% earnings estimate miss reported after the market close on July 17.

SCSS hit an all-time high of $35.60 in April 2012 and has since moved into a shallow downtrend. It could be counted as a not very impressive correction, or as the first whisps of cloud heralding the advent of a major hurricane.

The Elliott wave count fits nicely as five-wave downtrend move. The current 5th wave would need to carry the price below the end of the third wave, $16.74 on April 17, to validate the count. That's a clean shot at a decline of more than 25.8%, something I'll welcome from a bear position any day.

If the move were a correction within an uptrend, then according to Elliott wave doctrine the count would need to be three waves down instead of five.

The the 5th SCSS breakout to the downside since the April 2012 peak. Three of the completed trades were profitable, for an average yield of 16.5% over 40 days. The one unsuccessful trade lost 6.9% in nine days.

The win/lose yield spread is 9.6%, a nice set of odds indeed.

SCSS was among three symbols listed as breakouts on Tuesday. The other symbols, both bull signals, failed confirmation on Wednesday. They are CEA and PT.

Select Comfort, headquartered in Minneapolis, Minnesota, makes and sells beds with adjustable firmness under the name Sleep Number.

Analysts seem as though they're yawning a bit over Select Comfort, coming down with a collective 10% enthusiasm rating.

Clearly, they haven't been looking at the balance sheet -- a 36% return on equity with no long-term debt, an extremely impressive set of numbers.

Yet, earnings peaked in 2012, in the 1st and 3rd quarters, and have been lower that those peaks in the three quarters that followed, with a string of downside earnings surprises. Clearly, a company that fails to make right whatever has injured earnings will typically see return on equity taper off, and perhaps even start adding debt.

Institutions own 95% of shares, and the price of the stock is above parity. It takes $1.41 in shares to control a dollar in sales.

SCSS on average trades 1.8 million shares a day, sufficient to support a moderate selection of option strike price with open interest running to three and four figures.

The bid/ask spread on front-month at-the-money puts is 6%, not bad for a stock trading below 3 million shares daily.

Implied volatility is running at 41%^, a bit below the six-month mid-point. It has been falling since mid-July, leveling out the past few days.

Options are pricing in confidence that 68.2% of trades will fall between $19.91 and $25.19 over the next month, for a potential gain or loss of 11.7%, and between $21.28 and $23.82 over the next week.

Options trading was quite slow on Wednesday, amounting to just 8% of five-day average volume for calls and 16% for puts.

The fair-price zone on Wednesday's 30-minute chart ran from $22.68 to $23.33, encompassing 68.2% of transactions surrounding the most-traded price, $23.10. SCSS opened above the zone and fell sharply in mid-day trading to end below the zone.

Select Comfort next publishes earnings on Oct. 14.

Decision for my account: I'll open a bear position in SCSS on Thursday if the signal is confirmed by trades below the breakout level, $23.32. 

At this point I intend to structure the position by selling vertical credit spreads, short the $22.50 calls and long the $25 calls. The position provides 4.5x leverage with a 2.7% cushion of profitability at expiration above Wednesday's close. The maximum potential yield is 35.1%.

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.

Elliott wave analysis tracks patterns in price movements. StockCharts has a good explainer. The principal practioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading. 

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.