Tuesday, January 21, 2014

SWKS: Divergent analyses

Update 1/29/2014: My ambiguity about the SWKS chart proved to be well founded. The price reversed on Jan. 24 with sufficient downward momentum for me to count wave 5 to the upside complete. That also completes wave 2 {+2} to the upside and marks the beginning of wave 3 {+2} to the downside, a correction of the rise from $19.21 on Nov. 5, 2012 to $31.80 on Jan. 17.

I'm removing SWKS from my Watchlist, having never opened a position.

Here is an updated chart:

Click on chart to enlarge.
SWKS 16 months daily bars

Skyworks Solutions Inc. (SWKS) broke above its 20-day price channel on Friday and confirmed the bull signal on Tuesday by continuing to trade beyond the channel's upper boundary.

A break above a resistance level set in 2012 suggests that rise is over and SWKS is about to begin a significant decline. But implied volatility and the odds tell a different tale.

The Chart

SWKS, like many tech stocks, hit its peak in 2000 and began a very long term downtrend. In terms of the Elliott wave frame that I've laid over the chart, this means five waves to the downside. By my count, SWKS began its wave 3 {+4} decline from $37.82 on Feb. 14, 2011.

Wave 1 {+3} ended at $13.72, and the wave 2 {+3} correction to the upside, at $31.44.

That $31.44 level is important because it marks the beginning of wave 1 {+2}, the first wave of the wave 3 {+3} decline that will carry the price below $13.72, which is the end of wave 1 {+3}

An Elliott principle rule forbids a second wave move beyond the start of the preceding first wave of the same degree. On Friday, SWKS broke the rule.

Click on chart to enlarge.
SWKS 20 years monthly bars (left), 3 years 2-day bars (center), 3 days 5-minute bars (right)
The break above the 20-day price channel came during a rapid rise that carried SWKS up to $32.60 on Friday, a 3.7% move above the $31.44 level. However, as the right-hand chart shows, it remained above that level for only a bit more than two hours.

Does that brief time span mean I can dismiss the overshoot from my analysis and move on to other things?

My favorite analogy for the collision between theory and reality is that posited by the Georgetown University professor Carroll Quigley. In his 1961 book of macro-history, The Evolution of Civilizations, Quigley compares structured theoretical analysis to the disordered reality of quartz crystals.

Although quartz crystals in theory take the form of six-sided objects, in nature they inevitably diverge from that ideal.

Quigely concludes that quartz crystals tend to take hexagonal form unless outside forces distort them. "The fact that ninety-nine percent are distorted does not deter the scientist from forming in his mind an idealized picture of an undistorted crystal," Quigley writes.

So it is with Elliott waves. I can find no reason beyond the brief overshoot to conclude that wave 3 {+2} has not yet completed its upward course. The SWKS chart is a quartz crystal that failed to measure up to the ideal.

By my count, SWKS began wave 3 {+2} to the downside on Friday from $32.60 That wave will decline by at least 41.1%, to below the wave 1 {+2} terminus, $19.21, and may well fall much further.

Another move above $31.44, one that persisted, would make my count invalid and would require a fresh analysis.

The Odds

This is the sixth SWKS bull signal since wave 2 {+2} began on Nov. 5, 2012. Of the five completed signals, only two were successful, yielding 6% over 39 days on average. The three unsuccessful signals lost 8.3% over 16 days on average.

The Company

Skyworks, headquartered in Woburn, Massachusetts, makes semiconductors for handling analog and mixed signals. The products are used in automobiles, cellular infrastructure and energy management, among other fields.

Analysts have high hopes for Skyworks' prospects, collectively coming down at a 64% enthusiasm rating.

Certainly, the financials justify that opinion. The company reports a 18% return on equity with no long-term debt.

Looking at the last 12 quarters, the company has earned a profit in each, with the 2013 quarters showing an acceleration over both the preceding and year-ago quarters. The company has produced an upside earnings surprise in each quarter.

The earnings yield is 5.1%, greater than 70% of other semiconductor companies. The stock is selling for 19.5 times earnings and is also priced at a premium to sales. It takes $3.12 in shares to control a dollar in sales.

The company pays no dividend and so retains all of its earnings for corporate use.

Institutions own 79% of shares. Skyworks next publishes earnings on April 28.

Liquidity and Volatility

SWKS on average trades 4.8 million shares a day and supports a wide selection of option strike prices spaced a dollar apart, with open interest running mainly to four figures. The front-month at-the-money bid/ask spread on calls is 5%.

Implied volatility stands at 27% after a two-day decline from 45%. It is at the 6th percentile of the annual range and is 6% below the quarterly historical volatility.

Low volatility, such as that shown by SWKS, implies higher prices ahead, which is at odds with my chart analysis. My preference is to buy low volatility, structuring my trade as a bull call options spread sold for credit.

Options are pricing in confidence that 68.2% of trades will fall between $28.72 and $33.62 over the next month, for a potential gain or loss of 7.9%, and between $29.99 and $32.35 over the next week.

Contracts are trading slowly today, with calls running at at 66% of their five-day average volume and puts at 61% of average.

Decision for my account

SWKS is a puzzle. The chart is telling me that a bull play would be unwise, and that opinion is confirmed by the odds. The collective opinion of traders, as expressed through implied volatility, is telling me the contrary.

At this point I have no reason to justify believing one analysis over the other. The prudent course is to let things play out a bit more before making a decision.

Aside from the chart, SWKS looks like a viable bull play. But the chart is an important part of my analysis and not to be ignored.

As noted in the chart analysis, a persistent price rise above $31.44 will invalidate my present bearish count.

I shall put SWKS on my Watchlist to see how it plays out. Whether I trade it or not will depend upon what other opportunities are available at the time. But I find the divergence between the chart and implied volatility to be interesting.


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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