Thursday, October 17, 2013

WAG: A drug store bull play

Update 12/9/2013: I exited WAG on Nov. 11, as options expiration neared, and set it on the Roll Shelf waiting for a fresh break above the 20-day price channel, which would be a signal to continue the position with fresh options.

That break never came, and WAG on Friday confirmed a break below the 20-day price channel, signalling an end to my efforts to roll it forward.

During the 25 day life of the position, WAG rose by 1.7%, or 25.4% annualized. The options spread produced a 17% yield on risk, or 248% annualized.

Update 10/17/2013: WAG continued to show upside momentum near the closing bell, and I've opened a bull position, structuring it as bull put vertical option spreads expiring in November. The position has 4:1 leverage with a maximum yield on risk at expiration of 19.9%. It provides a 3% hedge of profitability below the entry price.

Walgreen Co. (WAG) broke above its 20-day price channel on Wednesday and confirmed the bull signal by trading still higher today.

If I take this trade, it will mark my first step back into a bullish posture since I exited my upside positions in late September to avoid the risk of a market collapse amid Congressional refusal to allow payments on the national debt. (See my post "Rolling away from risk".)

The political dispute was resolved on Wednesday, for the next couple of months, at least.

Since some of Wednesday's trading was driven by political developments, I was mindful of the need to find a trade supported by uptrends that stood on their own, regardless of the politics.

Walgreen, as a chain of retail pharmacy and sundries stores, has no direct involvement with the sectors that would have been most harmed by a default. Instead, it rises and falls with the general economy.

And its chart shows that it has been in an uptrend since June 2012, buttressed by a clear Elliott wave pattern. I count WAG as being within wave V of the uptrend, beginning Aug. 28, 2013.

WAG 180 days 2-hour bars

My preferred count puts WAG in the middle uptrend, wave 3, of a five-wave larger upward movement. An alternate count puts it at wave 5, the final uptrend within the large movement. All of this is happening within wave V of the larger uptrend.

This is WAG's 7th bull signal since the present major uptrend began in 2012. Four of the completed trades were successful, on average yielding an 11.4% profit over 34 days, compared to two unsuccessful trades that lost 6% over 10 days, on average.

It is the 2nd bull signal within wave V, which began last August. The completed signal was successful, although barely. It earned a 1.1% profit over 12 days.

There is a substantial difference in outcome between the preferred count and the alternate count because of the Elliott wave rule that says that wave 3 cannot be the shortest of the three uptrending waves; 1, 3 and 5.

Wave 1 is $9.99 in length, so under the rule, either the current wave 3 must be longer or the future wave 5 must be shorter.

Under the preferred count, if wave 3 is to cover more distance than wave 1 did, it must move above $64.53, an 11% gain over the present price.

Under the alternate count, wave 3 is complete and is longer than wave 1 was, so nothing can be said about the length of the present wave 5 except that it must move higher than wave 4. It did that on Wednesday when it broke above the price channel.

Also, today, WAG hit its 52-week high, considered a milestone by longer-term traders.

The evidence overall suggests that WAG has upside potential independent of any market euphoria over Congress finally getting its act together.

WAG was among 18 symbols that survived my initial screening. (See "Thursday's Prospects".)

I immediately tossed out three that were inverted-outcome or leveraged exchange-traded funds; I prefer to do my own fancy footwork rather than leaving it to money managers. They are FAZ, QLD and ERY.

One symbol, KSS, had a notice of earnings within 30 days pop up and was excluded.

That still left a lot to choose from. I rather arbitrarily removed all the symbols with low open interest on their options.

Of the remainder, I turned away from the two remaining exchange-traded funds, QQQ and EWY on the theory that the broader holdings characteristic of ETFs are more likely to reflect the ephemeral relief rally.

Of the final four, SPLS was uptrending within a fairly recent downtrend; I generally like to see the trends all aligned in my favor. TJX showed lower upside momentum than I like.

That left it to a choice between BLOX and WAG, and I chose WAG because of its higher volume.

Walgreen, headquartered in Deerfield, Illinois, operates a drugstore chain of more than 8,000 stores in the United States. About 60% of its market capitalization comes from sales of prescription drugs.

Analysts have a favorable view of its prospects, coming down with a collective 16% enthusiasm rating.

The company reports 16% return on equity with fairly low debt amounting to 23% of equity.

The peak quarter for business appears to be the first quarter of the year -- wintertime sniffles, presumably -- and profits in that quarter have grown year over year for the past three years.

Walgreen has reported upside earnings surprises in nine of the last 12 quarters, and downside surprises in three.

Institutions own 62% of shares, which are priced at a discount; it takes 75 cents in shares to control a dollar in sales.

WAG on average trades 5.1 million shares a day and supports a small selection of option strike prices mainly spaced $2.50 apart.

The distribution of open interest is strange: Four strike prices at three and four figures descending from the front month for puts, and one month a four figures rising from the front month for calls, followed by strikes in double and single digits.

If I take this trade, I'll use puts to construct a bullish vertical spread, so the open interest distribution works in my favor. But still, it is a bit spooky to see such an options grid in a stock this liquid.

The front-month at-the-money bid/ask spread on calls is 2.9%.

Implied volatility stands at 24%. It has been moving in a series of sideways swings since the start of October.

Options are pricing in confidence that 68.2% of trades will fall between $54.28 and $62.26 over the next month, for a potential gain or loss of 6.8%, and between $56.35 and $60.19 over the next week.

Trading in call contracts is quite heavy, and more than double the five-day average volume. Puts are running at about 80% of average.

Walgreen next publishes earnings on Dec. 16. It goes ex-dividend on Nov. 14 for a quarterly payout yielding 2.16% annualized at today's prices.

Decision for my account: Despite the wave count ambiguity, I intend to open a bull position in WAG if it continues to show upside momentum in the last half hour of trading today. If momentum falters, then I'll put it on the Watchlist.

There's no way of telling whether the present wave will be long or short, but WAG is liquid enough that I can rely on the hedging abilities options bring to the table to protect me from a rapid reversal. I'll structure the position as bull put vertical options spreads.


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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