Monday, November 11, 2013

HTS: Bear signal on a REIT

Update 11/12/2013: I left HTS sitting on the Watchlist on Monday while I thought through two issues: The high dividend yield and the wide bid/ask spread on options. I've decided those two factors are sufficient to reject a trade and I won't be opening a bear position in HTS.

Hatteras Financial Corp. (HTS) ended a sideways correction that began Aug. 19 when it broke below its 20-day price channel on Friday. It continued the decline today, confirming the bear signal.

The Elliott wave count from the peak of $31.98 set on Dec. 7, 2010 suggests that HTS is in the final stages of a wave III decline that began Sept. 21, 2012 from $29.68. That decline in turn may be part of a larger corrective wave that began in 2009 -- I don't find the chart to be entirely clear.

Once wave 5 of the larger scale wave III is complete, I expect a sideways Wave IV correction that will stay at or below the $20 area.

HTS 3-year 2-day bars (left), 90 days 1-hour bars (right)

The 21 completed HTS bear signals within wave III have failed twice for every success, producing a meager 1.4% win/lose yield spread.

I attribute those odds in part to the inclusion of two significant corrections within that timespan and a powerful wave 3 downtrend that produced fewer bear signals because of its power.

That's a long way of saying that although the odds are meager, they aren't ipso facto a deal killer.

HTS was among 13 symbols that survived my initial screening over the weekend. (See "Monday's Prospects".)

Two failed confirmation -- MET and PAY.

Three lacked sufficient liquidity for a bear trade -- ARR, CZZ and TCP.

One, KBH, committed a bear signal while holding a bullish rating from Zacks; I prefer the signal and the rating be aligned.

One, NE, has a chart that seems to be downtrending, although it is a tough chart to analyze.

That leaves five bull signals -- ETFC, PVTB, AGU, NYX and ICE -- plus the bear signal from HTS. I saw nothing against any of them at first glance but chose HTS for analysis for two reasons: It has a bearish ranking from Zacks, which aligns with the bear signal, and I'm generally a bit bearish on the markets, just as a gut feeling, and am not too interested in bull signals at this point.

I never underestimate gut feelings. We humans geniuses at pattern recognition. It's something we do beyond the realm of consciousness. So when I get a hunch, I figure there's probably some good reason boiling in my trader's brain that I ought to pay attention to.

Hatteras Financial, headquartered in Winston Salem, North Carolina, is a real-estate investment trust that invests mainly in single-family residential mortgage securities guaranteed by federal agencies -- Ginnie Mae, Fannie Mae and Freddie Mac.

Like most REITs, Hatteras pays a whopping big dividend, amounting to more than 13% a year. This is large enough to have a major impact on the price, which declines when the stock goes ex-dividend.

Options positions anticipate the dividend, which has the effect of lowering call premiums and raising put premiums.

If I trade HTS, I'll do it as a bear call spread, a bearish position constructed from those lower premium call options.

Analysts think poorly of Hatteras Financial's future prospects, collectively coming down at a negative 70% enthusiasm rating.

The company reports a 12% return on equity with no long-term debt, which looks pretty good. Earnings over the last three years tended to be fairly stable, until the most recent quarter, when the company reported a heavy loss, attributing it to a rebalancing of its mortgage portfolio.

From a story perspective, a trader must decide whether the rebalancing meets its purpose of making the company stronger.

Earnings have surprised to the downside in seven of the last 12 quarters, including the most recent, and to the upside in five quarters.

Institutions own 63% of shares, and the price has been bid up to speculative levels. It takes $3.50 in shares to control a dollar in sales.

HTS on average trades 1.6 million shares a day and supports a moderate selection of option strike prices spaced a dollar apart, with three figure open interest on calls and mainly no open interest on puts.

The front-month at-the-money bid/ask spread on puts is 14.3%, and on calls, which I would use for a trade, at 25%.

That's a far wider spread than I generally like to trade.

Implied volatility stands at 32%, in the upper quarter of the six-month range, and has been rising sharply since last week.

Options are pricing in confidence that 68.25 of trades will fall between $15.25 and $18.33 over the next month, for a potential gain or loss of 9.2%, and between $16.05 and $17.53 over the next week.

Contract action today is skewed toward puts, which are running at nearly double their five-day average volume. Calls are running at 40% of average.

Hatteras Financial next publishes earnings on Feb. 10. The stock goes ex-dividend in December for a quarterly payout yielding 13.1% at today's prices.

Decision for my account: There's a lot going on with HTS just from a technical standpoint -- the high dividend and the high bid/ask spreads. Plus, today is one of those strange market days, when the bond bazaar is closed but the stock medina and forex souk are open.

I'm not going to make a trading decision on HTS today. I'll revisit it on Tuesday and update this analysis with my decision.


My shorter-term 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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