Thursday, January 16, 2014

KYTH: The War on Double Chins

Update 2/14/2014: I expressed misgivings, after the fact, about having opened a bull position in KYTH. Those misgivings, prompted by my Elliott wave analysis, proved to be well founded. That same analysis told me how to respond to the next day's events.

KYTH pressed above the Feb. 11 high that I had labeled the peak of 3 {-1} and then moved down to below the end of wave 4 {-1}. That requires a change in my count, moving the end of wave 3 {-1} to the $50.98 high set on Feb. 14, and exiting the position I entered the day before.
KYTH 30 days 1-hour bars
The chart is ambiguous. The wave 3 {-1} peak could also be wave 5 {-1}, ending wave 5 to the upside and setting up decline of larger degree.

My position in KYTH, over the one day that I held it, lost 2.4%, or 866% annualized.

Update 2/13/2014: I re-opened my bull position in KYTH; the wave 4 {-1} correction was fairly shallow. However, upon a closer look at the chart, I can see that it is well possible that wave 4 {-1} is not yet complete and and may reverse back to the downside. 

Click on chart to enlarge.
KYTH 90 days 1-hour bars
This will be the case of what I've labelled wave 4 {-1} is in fact wave A {-2} of a three-wave correction. A move above $49.98, the peak of wave 3 {-1} on Feb. 11, will mean that my count is correct and I was right to re-enter. A reversal below $49.98 will mean that wave 4 {-1} to the downside is still in progress, and I'll need to decide whether to ride it out or close.

I structured the position as long shares.

Update 2/3/2014: I've closed my bull position in KYTH. The price has moved up above the wave 3 peak and has paused as what could, conceivably, be counted as the wave 5 peak of $46.71 on Jan. 30, ushering in a downward correction if my count is correct.

In other words, I've taken profits.

KYTH rose by 7.1% over the 18 days I held my position, which was structured as long shares. The gain works out to 144.6% annualized.

I'll keep KYTH on my Watchlist for awhile. If the rise has not yet ended, then I'll consider rolling into a new bull position.

Update 1/16/2014: KYTH showed sufficient upward momentum in the half hour before the closing bell. I've opened a bull position, structured as long shares.

Kythera Biopharmaceuticals Inc. (KYTH) broke past resistance to the upside on Wednesday and continued higher today, sending a bull signal and confirming that a correction to the downside had indeed ended at $33.67 on Jan. 6.

KYTH is a small-cap stock with a short history. It began trading on Oct. 11, 2012, opening at $18.49. At the longest time-frame available, KYTH began its present rise from $14.07 on March 10, 2013.

The Chart

The Elliott wave frame I've laid over the chart showed KYTH to be in the final wave up, wave 5 {+2},  from that March 10, 2013 beginning, but in the first stage of that final push, wave 1 {+3}.

Drilling down one degree lower, I count KYTH to be in wave 3 from $28.37 on Jan. 13 of this year.

Click on chart to enlarge.
KYTH 1 year daily bars (left), 2 months hourly bars (right)
The Elliott wave rules require the present wave 5 {+2} to exceed $47.85, the terminus of the middle wave of the same degree, wave 3 {+2}, and there is under those rules no upward boundary to its rise.

From today's opening, KYTH has upside potential of at least 16.6%.

If the price fails to push above that level, then it means that my count is incorrect. A drop below the beginning of the present wave 3, $28.37, would invalidate the count without question. That is a 30.9% decline from today's opening. My exit rules would get me out long before that much damage had been done.

And in fact a decline below the wave 1 peak of $40.15 on Jan. 10 would be a good indicator that my count is in error. That's a 2.2% decline.

KYTH, then, has minimum upside potential of 16.6% and minimum downside potential 2.2% before my count breaks. I like that risk/reward ratio.

Odds and Yields

This is the fourth KYTH bull signal since the March 10, 2013 low.

Two of the completed signals were successful, on average yielding 31.3% over 43 days. The one unsuccessful signal lost 13% over, coincidentally, 13 days.

The resulting 18.3% win/lose yield spread is quite high.

The favorable odds tell me that, at least in this limited time frame, KYTH isn't prone to whipsaws, and its uptrends are of such a magnitude as to produce large profits.

The Company

Kythera Biopharmaceutics, headquartered in Calabasas, California, is a drug development company focused on the aesthetic drugs market. These are medicines that erase the ravages of time and make people pretty.

The company's product, ATX-101, is in the late stage of development. It is an injection that reduces fat in locations on the face that produces the double chin.

As a development stage pharmaceutical house, Kythera is prone to news surprises from the regulatory agencies. I find companies in this sector to be risky, which doesn't mean that they're a bad deal, only that the risk must be managed.

The handful of analysts who follow Kythera are universally positive about its prospects, coming down with a rare 100% enthusiasm rating.

As is almost always the case with development houses in the drug sector, the analysts' assessments are based on future promise, not present performance.

Kythera reports return on equity of negative 36% with long-term debt amounting to 20% of equity.

The company has reported losses in all five of the quarters since it went public, although the last three produced positive surprises. Also, each quarter has come in with smaller loss than the quarter before.

The loss yield amounts to negative 7.7%.

Institutions own 78% of shares. The company pays no dividend. Kythera next publishes earnings on March 21.

Liquidity and Volatility

KYTH on average trades 372,000 shares a day and supports an extremely narrow selection of option strike prices spaced $5 apart, with open interest running in the double digits near the money. The front-month at-the-money bid/ask spread on calls is 47.4%.

The options aren't liquid enough to trade under my preferences. Any bull position I might take in KYTH will be as long shares.

Implied volatility stands at 59%, at the 71st percentile of the three-month range. Volatility has been in a shallow decline since Jan. 7.

Options are pricing in confidence that 68.2% of trades will fall between $34.75 and $49.01 over the next month, for a potential gain or loss of 17%, and between $38.46 and $45.31 over the next week.

Contracts are trading slowly today, with puts running at 48% of their five-day average volume and calls at 20%.

Decision for My Account

There are risks with this stock, both because of the sector and because the company is betting on a single product to treat a single problem, the equivalent of putting all chips on 14 before the roulette wheel spins.

The chart represents the consensus of the market, and its message is that a bull play on KYTH is a reasonable risk.

I intend to open a bull position on KYTH, structured as long shares, if momentum continues in the half hour before the closing bell. If momentum falters, then I'll add KYTH to my Watchlist as a potential future trade.


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.

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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