Wednesday, September 25, 2013

JCP: Retail bear play

Update 9/27/2013: Penney announced it is pricing its public offering of 84 million shares at $9.65 per share. This moves JCP's chart out of the realm of speculation to reaction to news. The News Exclusions provision of my trading rules says,
Symbols that break out the day of or immediately following a major news announcement may optionally be excluded from trading on those grounds. The decision to trade or not will be based on a judgement of the degree to which continued price movement is likely, a highly subjective call.
In this case, my "highly subjective call" is to remove JCP from my Watchlist. I won't be making a trade based on the bear signal of Sept. 24.

Update 9/25/2013: To the right is a chart of JCP as it stood 30 minutes before the open bell. The price is in deep pit territory; it's the lowest it has been for the past 20 years.
JCP 9/25/2013 5-minute bars

I find no way to define a resistance point, a price that, if pierced, marks the end of resistance, beyond today's low of $9.93. JCP is on the way down, and at the micro level -- a chart with 5-minute bars, it is in a third wave down, which tends to be the most powerful portion of a decline.

So, as the best port in this particular storm, I'll revisit the trade if JCP falls below $9.93.

J.C. Penney Co. Inc. (JCP) is a case too far too fast. After breaking below its 20-day price channel on Tuesday, it fell 14.8% today in the first 65 minutes of trading. Atypically for liquid stocks, the rapid decline happened entirely after the opening bell rather than in the pre-market trading.

JCP has been in a downtrend since from its $43.18 peak on Feb. 9, 2012. The trend is taking the Elliott wave form of a five-wave decline, the first, third and fifth waves propelling the price downward, interspersed by second- and fourth-wave corrections to the upside.
JCP 3 years 2-day bars

That's a long fall over the longer term, and a sharp fall over the very near term.

Happily for rational traders, there is a way to estimate how much more downside potential JCP has. Unhappily, the answer is so shocking as to be useless.

Elliott wave doctrine says that the third wave in a five-wave decline can never be the shortest.

In the downtrend from February 2012, wave 1 ws $24.12 long and wave 3 was $19 long. The imposes on wave 5 the duty of being less than $19 in length. Otherwise, the count is wrong and must be reconsidered.

The problem is, the JCP wave count is quite clear and I don't see a viable alternate count. Could be wrong, but I don't see it.

So far wave 5 has covered $9.70. It will reach $19 in length if it falls an additional $9.30.

The shocking part is that a fall of that magnitude would bring JCP down into penny stock range, at 62 cents per share.

It seems unlikely that the company will reach such dire straights, despite its present problems, so arguably wave 5 is within $9 of its end. That's still a huge percentage drop, but there are no guarantees that it will fall that far. It is equally likely to have come to an end today.

The end of wave 5 will bring an upside correction of the fall from $43.18 to $9.93. Typical corrections are:
  • 38.2%, to $22.63
  • 50%, to $26.56
  • 61.8%, to $30.48
No guarantees, obviously, in the world of the markets. But retracements to those levels are a common occurrence. 

The internal count of wave 5, however, gives no such assurance. Wave i is shorter than wave 3, so wave v can be of any length without breaking the count.

This is JCP's ninth bear signal since the downtrend began in February 2012. Five of the completed signals were profitable, on average yielding 11% over 35 days. The unsuccessful trades lost 10% on average over 13 days. The win/lose yield spread is quite narrow, at 1%.

There have been two completed bull signals since wave 5 began on May 24, 2013. One was successful, for a 2.6% profit over 25 days, and one was unsuccessful, losing 8.6% over 14 days. This makes for a negative 6% win/lose yield spread, which is quite awful.

JCP was the sole survivor of last night's initial screening. (See "Wednesday's Prospects".)

The retailer, headquartered in Plano, Texas, needs no introduction. It was founded in 1902 and has been a household name for a long time as a place for goods priced for regular folk. (Its name back in the day was sometimes pronounced with a faux French accent to give it some class: J.C. Pen-NAY.)

The forces that have put many sectors of the economy under pressure have not spared retail. The Internet has made a far greater selection of goods available to people for prices that match or improve on Penney's. Globalization in manufacturing has helped spur the rise of mega-competitors such as Wal-Mart. Infighting in the Penney executive suite this year has made the markets uneasy.

So it is no wonder that analysts are somewhat less than enthusiastic about Penney, giving it collectively a negative 44% enthusiasm rating. Remember that I'm considering a bear play, so negative is good.

And a good thing that is. Return on equity is a negative 47%, and debt is quite high at more than double equity.

Penney last earned a profit in the 4th quarter of 2011. In the six quarters that followed, it has seen, with one exception, increasingly greater losses. The exception was the 1st quarter of this year, when the company managed to trim losses while still losing money, but the decline resumed in the 2nd quarter, with a fall below the level reported in the 4th quarter of 2012.

Earnings have seen downside surprises in each of the six unprofitable quarters.

Institutions own 86% of shares. If I were an institutional manager facing the need to justify my stewardship, I would be fairly eager to get JCP off of my holdings list. If that is indeed the way institutional managers feel, they will maintain downward pressure on prices.

The price is cheap. It takes only 22 cents in shares to control a dollar in sales.

JCP on average trades 19 million shares a day and supports a moderate selection of options strike prices spaced a dollar apart, with open interest in the four- and five-figure range at strikes that I would use to construct a position. The grid also has weekly options.

Implied volatility stands at 109%, near the top of the six-month range. It shot up from the bottom of the range, around 48%, beginning Sept. 13.

Options are pricing in confidence that 68.25 of trades will fall between $7.09 and $13.57 over the next month, for a potential gain or loss of 31.4%, and from $8.77 to $11.89 over the next week.

Trading volume is running at 39% above the five-day average for calls, and 15% below average for puts.

J.C. Penney next publishes earnings on Nov. 19.

Decision for my account: Reason tells me that a decline of such magnitude over the span of an hour must be followed by profit taking and a retracement to the upside. And that is in fact what has happened, to a small extent, with 3-1/2 hours to go before the closing bell.
JCP 30 days 1-hour bars

The chart for the short term shows that in the internal count of wave v, the huge decline is a wave (3). If today's low so far, $9.93, is in fact the end of wave (3), then the next move up would be a wave (4) correction to the upside, that in turn would be followed by a slide to below $9.93.

The common retracement levels under such a scenario would be:
  • 38.2%, to $11.32
  • 50%, to $11.75
  • 61.8%, to 12.17
The least of these retracements amounts to a 14% upside move.

(I'm using three levels of waves here: the top level is wave 5, with wave 5 as the next smallest and wave (3) as the smallest in this discussion.)

I'll track JCP during the last hour of trading to see what happens to momentum, and update this posting with my observations, but given the very near term state of the chart, I'm not willing to commit to a trade at this point, even if downside momentum resumes.


My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

I use the number 68.2% in using applied volatility to calculate the expected trading range. 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

By preference I place my trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

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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