Monday, September 9, 2013

OCN: High-risk mortgages bull play

Update 10/2/2013: OCN fell below its 10-day price channel today, signalling closure of my bull position. I had rolled out of my October options spread on OCN early pending resolution of the debt-limit dispute in Washington, (see my post "Rolling away from risk"), so the position was on the shelf waiting for re-entry into a November options spread.

The close signal ends the possibility of a roll. I'm removing OCN from the shelf and won't be trading it again until there's a fresh bull or bear signal.

 OCN's stock price rose 3.1% over the 18-day life of the position, for an annualized increase of 63.3%. The options spread produced a 10.4% yield on risk, or 211% annualized.

Ocwen Financial Corp. (OCN) is in the final push of an uptrend that began in April 2013, signaled by a break above its 20-day price channel on Friday. The bull signal was confirmed today as OCN traded still higher.

The bigger picture suggests that OCN has room to rise following a shorter-term correction.
OCN 5 years 4-day bars

Using Elliott wave analysis, I count OCN has being in the third wave of a five wave rise that began in October 2008 from $5.27.

The present third wave began in October 2010 from $8.30 and has carried the price to today's high, so far, of $55.95.

Within that third wave (3) I count OCN has being in the fifth (v) and final wave, from $34.10 on April 22.

Under Elliott wave rules, the third wave cannot be the shortest of the three rising waves in a bull trend. The first wave (i) at the level we're discussing is longer than the third wave (iii), which came in at $27.64. So the fifth wave (v) cannot go higher than $61.64 without invalidating my count.

That gives maximum potential of 10.3%, with no guarantees that that level will be attained.

OCN has had two prior bull signals within the present fifth wave, both profitable with an average yield of 5.5% over 27 days.

Since the present wave began in 2008, OCN has completed seven bull signals, four successful for an average yield of 28.5% over 51 days, and three unsuccessful for an average loss of 2.9% over 17 days.

OCN was one of 12 symbols that survived my initial screening over the weekend, all having broken out to the upside. (See "Monday's Prospects".)

All confirmed their bull signals in trading today.

In further analysis, I rejected WY because it is in a downtrend, and HAS because it didn't break above prior resistance to a new high.

ADTN and CCI failed to make the cut  because they were falling markedly intraday in early trading.

I turned away from SONS, EVR, WWWW, TRGP and CW because of low open interest on their options.

PEUGY is the least liquid symbol among the survivors, although it has a narrow bid/ask spread on shares.

WLK also has illiquid options, but I've decided to take a further look at it because of its strong bullish rating by Zacks.

That left OCN has the sole survivor with liquid options.

Ocwen Financial, headquartered in Atlanta, Georgia, is a holding company that services and originates mortgage loans. And not just any loans. Ocwen bills itself as "the industry leader in servicing high-risk loans".

With higher risk comes greater rewards. As the economy recovers, slowly, and the housing industry recovers, a bit faster, I suspect that trader interest in Ocwen is prompted by a conviction that the worst is over and greater risk is a reasonable trading goal.

Certainly analysts don't see risk as a deal killer. They collectively give Ocwen an 86% enthusiasm rating, far higher than I usually see in any sector.

The company reports return on equity of 18%, but with high levels of debt, amounting to more than two and a half times equity. Financial companies in my experience typically carry high levels of debt, but even so, this seems high to me.

Looking at the last 12 quarters, Ocwen has been profitable in the last 11, suffering its only loss of the period back in 2010. Three of the 12 quarters produced earnings surprises to the upside, and the other nine surprised to the downside.

Institutions own 77% of shares, and the price has been bid up to where it takes $5.27 in shares to control a dollar in sales.

OCN on average trades 1.4 million shares a day and supports a moderate selection of option strike prices with open interest running to three and four figures. This is the pattern I see when there is a lot of speculation in a stock.

Option trading today supports that characterization, with call options running nearly seven and a half times their five-day average volume, and puts running a bit more than two and a half times average.

Front-month at-the-money calls have a 4% bid/ask spread.

Implied volatility stands at 35%, in the bottom third of the six-month range, and has been stairstepping higher from mid-August.

Options are pricing in confidence that 68.2% of trades will fall between $49.64 and $60.86 over the next month, for a potential gain or loss of 10.2%, and between $52.56 and $57.94 over the next week.

The fair-price zone on today's 30-minute chart runs from $55.12 to $55.65, encompassing 68.25 of transactions surrounding the most-traded price, $55.29. OCN opened above the zone and fell steadily for 90 minutes to near the floor, and then bounced slightly.

Ocwen next publishes earnings on Oct. 28.

Decision for my account: This decision hinges on the Elliott wave analysis, and more specifically, on how much time we have left before the expected correction. The level I'm looking at (the lower case roman numerals on the chart) is fairly large scale, encompassing trends that can last for up to a year, although there are no guarantees. The present fifth wave (v) is about five months along. The distance between now and the time I shall close my October options is about four weeks.

So it's a risk, but I judge it to be an acceptable one. The "no guarantees" caveat given above means that I could be horribly wrong -- the fifth wave could end tomorrow -- and so I must be hard headed about my stop/loss point should it be hit.

I've opened a bull position in OCN, structuring it as a vertical options spread expiring in October and sold for credit. The leverage is 2.4:1 with maximum yield of 27.5% and a hedge of a 1.8% cushion of profitability below the price of the stock at entry.


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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