Tuesday, October 8, 2013

TGT: Dueling chart interpretations

Update 11/11/2013: I've been looking to reversal downward to close my bear call spread on TGT, guided by the risk/reward ratio of holding to near expiration vs. exiting immediately.

The clock ran out today, and I closed the position for a loss. The risk/reward ratio has remained in favor of holding -- I had more to gain if the stock rose to the upper one standard deviation boundary than to lose if it fell to the lower 1SD boundary.

During the 34 day lifespan of the bear position, the stock rose by 5.3%, or 57.3% annualized. That produced a loss on the options spreads of a negative 87.5% yield on risk, or negative 939.3% annualized.

On the chart, TGT has peaked only slightly above the terminus of wave 4 in the chart accompanying the original analysis (the second chart below). That suggests at the possibility that TGT has more downside potential.

However, by my rules TGT lost me on Oct. 30, when it closed above the 20-day price channel. Although it has continued to meander sideways since, a break above the channel forecloses the possibility of rolling TGT into a new bear position.

Update 10/17/2013: TGT moved above its 10-day price channel on Wednesday and traveled still higher today, providing a close signal for my bear position. Altogether, the two days covered 2.6% low to high.

I've structured TGT as bear call option spreads, which means maximum profit or maximum loss happen at expiration, on Nov. 15.

The magnitude of the rise has pushed the price to near the maximum loss point. 

Expiration is a month away, and a lot can happen between now and then. My reward/risk calculation suggests that I shouldn't exit just yet. My potential gain if things turn around is nearly double my potential loss. My preference is to keep the position open as long as the reward/risk ratio is in my favor.

TGT 30 days 1-hour bars

Elliott wave analysis suggests the 10-day channel breakout is part of an uptrend within a downward zig-zag correction, a wave A. Internally, that wave has five waves and is presently within wave iii to the upside. Ahead lies a wave iv correction to the downside, and then an upward trending wave v that will top the end of wave iii but will end below $65.59, the terminus of the larger scale wave 4.

Complicating things, the 20-day price channel's upper boundary is at $65.49. A rise above that level under my entry rules would generate a bull signal, requiring that the position be closed immediately.

This is all happening on a small scale. Wave A has done at least half its work within nine calendar days. I can afford to wait.

If TGT moves past $65.59, that means my count is wrong and by the chart exiting the position becomes the more prudent course. However, that level would increase my reward/risk ratio and would argue that I should continue to hold the position.

Bottom line: It's an ambiguous decision of the sort I really like to avoid. I anticipate coming out of this with a clearer set of exit rules that will avoid such future quandaries.

Update 10/8/2013: TGT fell immediately upon opening at $62.72 today and never moved that far north again. From 2:30 p.m. New York time onward it stayed in a holding pattern, remaining a few cents above $62.20 until the last quarter hour of trading, when it resumed its fall.

The downside momentum was sufficient to meet my preferences. Shortly before the final decline of the day began began, I opened a bear position in TGT, structuring it as bear call option spreads expiring in November. The position provides leverage of 5:1, a potential yield on risk at expiration of 56.3%, and a 1.8% hedge of profitability above the entry price.

Target Corp. (TGT), like many retailers, peaked in July. The $73.50 high on July 24 began a downtrend that continued to work itself out on Monday as TGT broke below its 20-day price channel, producing a bear signal.

It is the second bear signal of the downtrend. The first, which began 15 trading days after the peak, produced a 5.9% profit over 18 days.

Using Elliott wave analysis, I've labeled that decline as wave iii -- wave i was the day after the peak, and it was followed by a two-week pause that constituted wave ii.

TGT 20 days 15-minute bars

The present downtrend, wave iii, began on Aug. 19 from $65.59 and took 12 trading days to work its way down to the breakout level.

I'm using lower-case Roman numerals in my count because the near-term trend is contained by a larger scale wave 5 to the downside, part of a decline from the $73.50 peak on July 24.

That peak, in turn, is the end of wave C up and, best assessment, the point that marks the end of a larger trend wave (A) that began in March 2009 from $25, at the depths of the Great Recession.

July marked the end of a four-year uptrend that nearly tripled the price. The downtrend that began in July can be expected to be roughly of the same order of magnitude as the preceding uptrend and is labeled wave (B).

The downtrend has not yet progressed far enough to say how many levels down our present wave 4 is from wave (A). Using Fibonacci regression, I can name some likely retracement targets for wave (B): Down 38.2% to $54.97, down 50% to $49.25 or down 61.8% to $43.53.

Fibonacci levels of course come without guarantees. Anecdotally, they seem to provide resistance levels on many of the charts I've worked with.

Returning to the near-term, the odd thing about my count is the length and power of wave i. It looks more like a wave iii.

An alternative count moves the end of wave i closer to its wave 4 origin and then counts down from there. I rejected it because it was impossible to draw a valid price channel, a technique that I've found to be useful in defining the beginning and ends of waves.

The choice between the dueling counts has large implications for TGT's future course.

My preferred count puts the price in wave iii, which will be followed by a wave iv correction to the upside ending below $64.08, and then a wave v down to complete the downtrend.

The alternative count puts the price in wave v, nearing the end of the uptrend, and it will be followed by an upside correction that could rise as high as $65.59.

The preferred count gives more time for a downward correction than the alternate count does, although neither requires a rapid termination of the downtrend.

Elliott wave rules require that a third wave not be the shortest of waves 1, 3, or 5.

Under the preferred count, wave iii is still shorter than wave i; it must decline to below $61.64 to meet the rule, unless the future wave v comes in as the shortest. Under the alternate count, wave iii is the longest wave so far.

TGT was not among the survivors of my initial screening, which covered breakouts from October 2011, when the present S&P 500 trend began. (See "Tuesday's Prospects".)

None of the four symbols that did survive has sufficient options liquidity to support a bear trade.

So I did an alternate analysis, using the market break on May 21 of this year as starting point. From that date the S&P 500 abandoned its unrelenting rise and began a series of undulations that indeed set higher highs, but with a fair degree of angst and struggle.

That alternate analysis produced four survivors, all having broken out to the downside: TGT, GPS, LQDT and BTI.

Two of those symbols, TGT and GPS, have sufficient options liquidity to trade. TGT has slightly better historical odds of success in bear trades, and Zacks has a more negative opinion of its prospects, so I went with TGT for my analysis.

Target, headquartered in Minneapolis, Minnesota,, is a bricks and mortar presence in the United States and Canada. It is second only to Walmart in the ranks of discount U.S. retailers.

Analysts collectively have a low opinion of Target's prospects, giving it a negative 37% enthusiasm rating.

The company has a fairly high return on equity, at 19%, but the debt is also a bit on the high side, at 79% of equity.

Target, like most retailers, lives by its 4th quarter holiday season results. The past three 4th quarter earnings reports have exceeded the year-ago quarter, although two, including the most recent 4th quarter, have surprised to the downside.

All of the 12 quarters I'm using in this analysis have been profitable. Eight showed upside earnings surprises, and four surprised to the downside, including two of the last three quarters.

Institutions own 83% of shares and the price has been hammered down to where it takes only 54 cents in shares to control a dollar in sales.

TGT on average trades 4 million shares a day and supports a small selection of option strike prices spaced $2.50 apart. Open interest for the front-month at-the-money puts is 2.5%.

Implied volatility stands at 22%, near the peak of the six-month range. It has been on the rise since mid-September, one of a series of wide swings that has defined the past six months.

Options are pricing in confidence that 68.2% of trades will fall between $58.41 and $66.31 over the next year, for a potential gain or loss of 6.3%, and between $60.46 and $64.26 over the next week.

Contracts are trading actively today on the put side, with volume running 2-3/4 times the five-day average. Calls are at near their average volume.

Target next publishes earnings on Nov. 21. The stock goes ex-dividend on Nov. 18 for a quarterly payout yielding 2.76% annualized at today's prices.

Decision for my account: Despite the uncertainly in the Elliott wave analysis of the near term, I shall open a bear position in TGT if downward momentum continues into the final half hour before the closing bell.

Even the alternate count gives room for profit on a short-term trade. I intend to structure my position as bear call spreads expiring in mid-November.

I'll update this analysis with details of the trade if it happens. If momentum falters, I'll put TGT on the shelf as a potential trade if the downward slide 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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