CHL: How free is the market?

Update 4/8/2014: I rolled out of my CHL on March 21 and have been waiting ever since for a chance to roll them into a new position. That chance never came, and on April 7 CHL closed above its 10-day price channel and confirmed the signal the next day by closing still higher.

I've removed CHL from my Roll Shelf and calculated the results.

CHL's stock price declined 17.4% over the 72-day lifespan of the position, or -88.3% annualized. My bear put vertical options spreads gained 46.4% over the period, or 235.2% annualized.

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Update 1/8/2014: I've opened a bear position in CHL, structuring it as a bear put spread, bought with a debit and expiring in June. 

The implied volatility continued to fall after I posted this analysis, and so I switched my trade strategy from a short vertical spread to long, since debit spreads tend to do better in periods of lower volatility.

The updated chart, below, shows CHL continuing to work lower in wave 3 {+1}. Within that wave, I count CHL as being in the middle portion of its decline, wave 3.

Click on chart to enlarge.

CHL 180 days 4-hour bars

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China Mobile Ltd. (CHL) is a hard chart to analyze. It dropped from a peak of $104 in October 2007, that much is clear. But after completing the third wave of the decline, it embarked on a meandering course that looks suspiciously like a managed market.

CHL is traded natively on the Hong Kong Stock Exchange. The New York Stock Exchange symbol, CHL, is an American depository receipt, a sort of echo symbol  for the convenience of American traders. It is, however, a very loud echo, with fine liquidity, and so demands to be taken seriously as a trading vehicle.

I'm going to take a leap in defining CHL, which is a state-owned enterprise subject to more bureaucratic regulation than Americans think is proper with a capitalist enterprise. It's a freely traded stock with Chinese characteristics.

That makes it very much akin to the Swiss franc, which trades freely within boundaries set by the government. The existence of boundaries also seems to be the lesson of the CHL chart.

Applying Elliott wave analysis to a shorter timespan, I find that CHL began wave 3 {+1} to the downside from $56.50 on Dec. 5. The decline confirmed that it is a third wave by breaking below the start of wave 2 {+1} in trading today.

Click on chart to enlarge.

CHL 6 years 9 months weekly bars (left), 90 days hourly bars (right)

Wave 1 {+1} and wave 2 {+1} each took more than a month to complete, and so the present wave, if it is proportion, could be expected to last well into January. There is no rule requiring proportionallity, but often waves are.

Back to the idea of a managed market. The lows have often tended to be between $46.40 and $46.50 in the past four years, with one break that went as low as $44.71. If $46.50 is the regulatory signal to intervene, then that provides 9.8% of downside, plenty of room for a trader with American characteristics to make a profit.

One thing for sure: The nature of this chart increases the risk of the trade. I'm not averse to risk, as long as I can identify it.

China Mobile provides mobile telcom services in China, with about 740 million subscribers, making it the largest mobile phone operator in the world.

It is followed by less than a handful of American analysts, and so I won't calculate an enthusiasm rating.

The financials are excellent, with return on equity of 18% and no long-term debt.

Profits have risen in each of the last three years. CHL has an earnings yield of 10.2%, higher than 77% of other companies in communications services. Of that, 4.2% is paid out in dividends, meaning the company is retaining 58.5% of profits.

The stock is priced at 9.8 times earnings, and is also selling at a premium to sales. It takes $2.12 in shares to control a dollar in sales.

CHL on average trades 1.1 million shares a day and has a wide selection of option strike prices spaced a dollar apart, with open interest running to four figures near the money. The front-month at-the-money bid/ask spread on puts is 9.7%.

Implied volatility stands at 21%, in the 76th percentile of the monthly range. It has risen today over the day before, after declining for a day from the monthly peak of 22%.

Options are pricing in confidence that 68.2% of trades will fall between $48.42 and $54.74 over the next month, for a potential gain or loss of 6.1%, and between $50.06 and $53.10 over the next week.

Contracts are trading quite actively today, with calls at nearly three times their five-day average volume and puts at more than double the average.

China Mobile next reports earnings in February. The stock goes ex-dividend in March for a semi-annual payout yielding 4.34% annualized.

Decision for my account: CHL is a riskier than normal play, but with sufficient liquidity to provide a hedge. I intend to open a bear position if downward momentum continues into the half hour before the closing bell, structuring it as a bear call optons spread sold for credit.

References

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. The principal practitioner 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. 

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

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.

Disclaimer

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.