Monday, September 9, 2013

PFE: Pharmaceutical sideways play

Update 1/10/2014: Farewell, PFE! You won't be missed.

PFE, as noted in the 10/19 update ended up as 1,000 short shares representing a significant loss, and I've been trying ever since to find the proper exit point. Today it came at last, I've bought back the short shares and don't intend to roll PFE foreward into another sideways play.

In addition to the original iron condor and the short shares resulting from the exercise, I also at one point had an insurance call that ended up earning a 2.1% profit over 42 days, or 1.1% annualized.

The total results for my PFE adventure, insurance call includes, are as follows.

The shares rose by 5% over the 97 days that I had open positions in PFE, or 18.9% annualized.

The loss on risk on the options and short shares was 1%, or a loss of 3.74% annualized.

All in all, that's cheap tuition for an intense lesson on managing such a difficult position. At exercise, my loss on risk was 5.1%. By using insurance and picking my exit, I managed to reduce the loss by 80%.

Regular readers who are aware of my close focus on charts will not be surprised that the chart was the key to my decision-making.

Click on chart to enlarge.
PFE 5 years weekly bars (left), 170 days 2-hour bars (right)

At the time of exercise, it was clear the PFE was in wave 3 of 5 {+1} to the upside, and at some point wave 3 had to end, setting up a wave 4 decline. My PFE holdings were in the form of short shares, I faced no deadline that would force me to exit against my advantage. In the meantime, I used long calls to mitigate my loss in the case of a major price rise.

And indeed, wave 4 began on Nov. 25. There was, of course, no way to know how far down it would travel, until Dec. 18 gave me an opportunity to set a target. That date, as it proved, was the start of an ascending triangle, with a flat ceiling and a rising floor.

In Elliott wave theory, a triangle touches its boundaries five times, labelled a through e, with the b wave sometimes breaking past the ceiling before retreating.

The high on Jan. 9 was the peak of b, and when that moved back into the triangle, it was clear that the lower bound would be somewhere around $30.60. That's about as good as things would get for bears going forward. Subsequent lows would come in at higher prices.

Also, in Elliott, the ceiling of the ascending triangle marks the direction of the breakout after the triangle ends. Wave e of the triangle was destined to give PFE a rise, perhaps to as high as $32. The price target is based on the traditional triangle lore that says the breakout will move the distance of the triangle's base.

When PFE hit $30.60, the triangle floor, I exited, freeing up the funds for future trades.

Update 10/19/2013: PFE is no longer a sideways play. My short options were exercised on Oct. 19, leaving short shares of stock in my account. Since the shares don't expire, I've had the luxury of waiting for the price to fall again, mitigating or eliminating my loss.

Having dipped my toes in that water last week with a sideways play on an ongoing symmetrical triangle (see my BIIB posting), I spent the weekend searching through high volume stocks for other triangles that might make interesting trades.
PFE 9 months daily bars

Pfizer Inc. (PFE) has been tracing a symmetrical triangle since late April and isn't due to reach its apex until mid-April 2014, although I would not want to carry positions across the next earnings announcement, Nov. 4.

The boundaries today run from $27.79 to $30.13 and of course, as is the nature of symmetrical triangles, will grow closer together as each day moves forward.

Symmetrical triangles are best played as iron condors, a combination of two vertical credit spreads: A bull put spread and a bear call spread. That structure provides credit up front and a range of profitability. If the price either rises above for falls below the range, then profits from the trade quickly disappear.

My present strategy is to set my stop/loss points near the break-even points on either side of the profitable zone. As the width of the triangle narrows, the likelihood of being stopped out declines.

The stock is presently trading nearly 50 cents above the triangle's lower boundary.

Pfizer, headquartered in New York City, is one of the world's largest pharmaceutical companies. Its flagship medicine, the extremely popular cholesterol lowering drug Lipitor, recently saw its patent expire, as the company scrambled to find a replacement.

Another flagship product, the erectile dysfunction drug Viagra, remains under copyright in the United States.

Analysts are optimistic about Pfizer's prospects, collectively giving it a 29% enthusiasm rating.

The company reports 19% return on equity and with moderately low debt amounting to 40% of equity.

Looking at the last 12 quarters, Pfizer has been consistently profitable, although 2013 has seen a slight decline below the median earnings for prior years. It has produced upside earnings surprises in 11 quarters, and a downside surprise in one, the 1st quarter of 2013.

Institutions own 72% of shares, and the price has been bid up to where it takes $3.44 in shares to control a dollar in sales.

PFE on average trades 24.7 million shares a day, sufficient to support a good selection of option strike prices spaced a dollar apart with open interest running to four and five figures. The front-month at-the-money bid/ask spread on calls is a miniscule 1.5%.

Implied volatility is running at 20%, on the low side these days. It stands slightly below the mid-point of the six-month range and has been rising since mid-August. For a sideways play such as I'm contemplating, low volatility is better than high.

Options are pricing in confidence that 68.2% of trades will fall between $26.50 and $29.81 over the next month, for a potential rise or fall of 5.9%, and between $27.36 and $28.95 over the next week.

Trading is middlin' to slow today, with calls running at 40% of their five-day average volume, and puts at 12% above average.

The fair-price zone on today's 30-minute chart runs from $28.10 to $28.21, encompassing 68.2% of transactions surrounding the most-traded price, $28.16. PFE opened above the zone, fell, to the zone floor in the first 90 minutes of trading, and has since oscillated to the ceiling and back toward the floor again.

Pfizer next publishes earnings on Nov. 4. The stock goes ex-dividend in October for a quarterly payout yielding 3.41% annualized at today's prices.

Decision for my account: I've opened an iron condor on PFE, sold for credit and expiring in October, short the $32 call and $28 put and long the $32 call and $26 put. That gives me 1.3:1 leverage in either direction. My yield is that my credit from the sale if PFE closes between $28 and $32, a best yield on risk at expiration of 62%.

I set my stop/loss points at the break-even prices, $27.50 on the downside and $30.50 on the upside, both beyond the present triangle boundaries.


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.

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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