Friday, August 16, 2013

MNKD: How bear plays are different

Update 10/7/2013: My September options spreads on MNKD expired worthless on Sept. 21, allowing me to keep the entire premium. I put them on the shelf awaiting a fresh breakout to the downside so I could roll them forward to October options.

The breakout was a long-time coming, and it was only today, in the November options trading period, that it happened. MNKD broke sharply below its 20-day price channel, providing the momentum I need to justify rolling into a new bear position.

However, the various factors that go into pricing options have moved against building a viable optoins spread a position. A bear call spread would have a high negative leverage -- the options would cost more than the stock.

This sort of thing often happens with low-priced stocks that have tradeable options; MNKD is going for $5.09 as I write. I could simply buy put options, but I really prefer a position that I can hedge, especially with the next earnings announcement coming up on Oct. 31.

So I have removed MNKD from the roll shelf and calculated the results. During its 36-day existence,Aug. 16 to Sept. 21, my bear position in MNKD saw the stock fall by 3%, or 29.9% annualized. The options spreads showed a 19.1% yield on risk, or 193.1% annualized.

MannKind Corp. (MNKD) joined the market's general rout on Thursday, pushing below its 20-day price channel the day after it broke above the channel. The price fell further today, confirming the bear signal.

The rapid retreat from Wednesday's peak of $8.70 was the second break this summer in an uptrend that began in October 2012.

MNKD 30 days 2-hour bar
Thursday was a heavy down day for stocks generally, with bear signals outnumbering bull signals 11:1 in my universe of 2,300 or so mid-cap and bigger stocks and exchange-traded funds.

Bear signals have been a rarity among the fish caught in my analytical net this year. But the times are changing, and MNKD gives me an opportunity to think about how bear trades differ from their bullish counterparts.

Bull plays are easy: Do a leveraged and hedged short options spread if open interest is three figures or better, and buy shares if its not.

The first (and preferred) choice applies to bear plays as well, but the second choice is somewhat more complex. Shares of a stock can be sold short only if they're available for the trader to borrow, and for lower liquidity stocks, they're unavailable. Generally, the stocks whose shares can be shorted also have options with sufficient open interest to trade.

Bear plays, then, tend to be biased toward bigger companies with high volume. The choices are limited, and that makes my holdings representative of a narrower segment of the economy.

Moreover, my analytical system breaks down somewhat early in a major trend change, which is where we appear to be today.

For screening, I rely on historical odds during the current trend in favor of a successful trade in the direction of the breakout. When the market has been in a bull trend for so long, there haven't been many successful bear trades. The pertinent question, really, becomes which bear trades lost the least, not how many were winners.

Eventually, if the bear trend continues, I'll be calculating those odds based on performance during the bear trend, but the trend at present is too new. There is no history. Often the current bear signal is the first of its kind in a long time.

At present I'm happy living with the contradictions in my odds calculations. Although we appear to be topping into a downtrend, that is in fact far from certain. I'm much happier selecting my bear trades from stocks that were bearish before the rest of the market jumped on board.

MNKD 3 years 2-day bar
And that applies to MNKD. My initial screening uses odds based on when the present uptrend in the S&P 500 began: Oct. 4, 2011. On that day MNKD closed at $3.70 and was in the midst of a downtrend that would eventually carry it down to $1.57 in May 2012.

That history gave MNKD a 50% success rate on bearish trades during the period, as compared with the rest of the market, which began their uptrend around that time.

More recent history has been less kind to MNKD's bearish creds. The uptrend from October 2012 has seen but one bear signal prior to the current one. It ended up losing 12% over 18 days.

That uptrend first faltered at a peak of $8 in June, declined to $5.70 the next week, producing the uptrend's lone bear signal along the way, and then began to work its way back to this week's ephemeral peak.

So I can say that MNKD is more bearish than most of the symbols I've dealt with over the past months. However, I cannot say that it's in a downtrend except in the most near-term frame, and I cannot say that it's in an uptrend unless I ignore the very long term frame.

Very long term, MNKD has traced a series of lower highs from $12.30 in 2009. This weeks faltering at $8.70 merely set a lower high.

If MNKD continues down to a lower low, below $1.57, then the very long term downtrend remains in force. If it reverses above that level, then it is positioned for what would be the beginnings of a new uptrend, or perhaps a triangle of some sort.

No trader can succeed at the craft without harboring a deep love of ambiguity.

MNKD was one of eight symbols that survived last night's initial screening, all having given bear signals. (See "Friday's Prospects".)

Two failed confirmation: ESRX and PMCS. The others lacked sufficient options liquidity to construct  a bear position. They are ARR, IRM, IRWD, KRO and MDP

MannKind, headquartered in Valencia, California, develops therapeutic medicines for diabetes, cancer and other diseases. It has all the great promise and tendency toward sudden movements based on news common to all biotech companies.

The handful of analysts following MannKind are split on its prospects, collectively coming down at a negative 20% enthusiasm rating.

The companies financials are the usual mishmash of a development company -- lots of hope but little on the books to show for it.

Return on assets is a negative 80%. Earnings are nothing but losses for the last 12 quarters, although the losses have tended to become smaller over time and half the quarters have produced upside earnings surprises. (Half have surprised to the downside, so its a full-cup-empty-cup surprise history.)

The price to sales ratio is so absurd that I'm reluctant to even put it down, but here goes: It takes $57,250 in shares to control a dollar in sales.

MNKD on average trades 14 million shares a day and supports a moderate selection of option strike prices with open interest mainly in the four figures. The front-month at-the-money put options have a narrow bid/ask spread of 6.5%.

Implied volatility stands a 1.1%, near the middle of the six-month range, following a sudden fall this week from 2.1%.

Options are pricing in confidence that 68.2% of trades will fall between $4.25 and $8.05 over the next month, for a potential gain or loss of 30.9%, and between $5.24 and $7.06 over the next week.

Put options today are trading 84% above their five-day average volume, and calls at 65% above average volume.

The fair-price zone on today's 30-minute chart runs from $6.04 to $6.40, encompassing 68.2% of transactions surrounding the most traded price, $6.22. The price opened today well above the zone and has fallen continually -- most dramatically in the first half hour -- to a position in the lower half of the zone.

MannKind next publishes earnings on Oct. 28.

Decision for my account: There's nothing not to like about MNKD as a bear play, except for the uncertainties that come with any pharmaceuticals play. The chart has its ambiguities but that is not unusual.

I've opened a bear position in MNKD, structuring it as a vertical options spread sold for credit and expiring in September, short the $7 calls and long the $8 calls. There is no leverage to speak of 1.02:1. The maximum potential yield at expiration is 19.1%. The position provides a 17% hedge of profitability at expiration.

It was hard to get a fill on this trade for some reason; I had to come 2 cents off my ask, shaving 3 percentage points from my potential profit. 


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

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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