Tuesday, February 4, 2014

FITB: Bearish on a regional bank

Update 3/14/2014: I've removed FITB from my Watchlist as a potential bear play. It closed above its 20-day price channel on March 4 and moved still higher subsequent days. I never opened a position in FITB based on this analysis, so the exit signal impacts the Watchlist only.

Fifth Third Bancorp (FITB) began a correction to the downside on Jan. 22 that will take back a significant portion of the rise from $9.13 on Aug. 23, 2011 to $21.97 on Jan. 22 of the current year.

The break below the 20-day price channel on Monday, which sent a bear signal, carried FITB beyond a support level, suggesting that there is considerable downside potential.

However, the FITB chart shows a tendency for trends to unexpectedly continue on their course well past their expiration date, so I can't conclusively count the FITB uptrend to have reached an end. If it hasn't then all of that downside potential disappears.

The Chart

Elliott wave analysis shows the Jan. 22 peak to have been the end of wave 3 {+3} to the upside, part of a broader rise within an upside correction from the Great Recession low of $1.01, set Feb. 20, 2009.

The correction is presently within the middle wave, 3 {+4} within the initial wave, A {+5} of wave 2 {+6}. In the very long term, there is much upside potential available to FITB.

In the nearer term, however, where my sandbox in situated, the potential is to the downside.

Click on chart to enlarge.
FITB 5 years 5 months 3-day bars (left), 90 days 1-hour bars (right)
If Jan. 22 was indeed the wave 3 {+3} peak, the most common Fibonacci retracement levels would carry the price down by 38.2% to $17.06, by 50% to $15.55 or by 61.8% to $14.03.

These are often observed levels where retracements pause or end, but not guarantees.

A move back above $21.97 would mean that Jan. 22 was not the peak and my count is incorrect. As long as that resistance level holds, then the downside potential that my analysis shows will remain in place.

There is a case to be made for wave 3 {+3} being incomplete. Elliott wave rules forbid the third wave of a trend from being shorter than both the first and the fifth waves. By my count, wave 3 {+3} is $12.84 in length, while wave 3 {+3} is longer, at $14.94 in length.

For the count to be valid, the future wave 5 {+3} will have to be shorter than the third wave's span of $12.94. Or, the price can reverse, invalidating the third wave end point of my count and continue to add to the length.

Typically, third waves are the longest of the three, but not always.

Odds and Yields

FITB has a sparse history of breakouts to the downside.

This is the first bear signal of the present wave 4 {+3} to the downside, so there is no history there.

At a higher degree, wave 5 {+2} to the upside, which began Oct. 9, 2013 and ended Jan. 22, had no bear signals.

It is only at the degree of wave 3 {+3} to the upside, which began Aug. 23, 2011, that I find completed bear signals. There have been six, divided evenly between success and unsuccessful.

That divide means that historically, bear signals from FITB have been as apt to produce whipsaws as not, and the downward momentum has been weak: The resulting win/lose yield spread is a negative 6.1%.

Arguably, of course, the reversal on Jan. 22 was the end of history so as FITB is concerned, so I don't consider these numbers in themselves to be a deal killer.

The Company

Fifth Third Bancorp, headquartered in Cincinnati, Ohio, operates 1,316 banking centers in 12 states in the American Midwest and Southeast regions.

Analysts collectively come down at a negative 40% enthusiasm rating for First Third.

The company reports return on equity of 11% with debt amounting to 71% of equity.

Earnings have tended to fluctuate in a sideways range, although there was a spike to the upside for the 2nd quarter of 2013. The company has surprised to the downside three times in the last three years, the most recent being in 2012.

Earnings yield is 9.84%, higher than 84% of other regional banks. The dividend yield at current prices is 2.32%.

Stocks are selling at 10 times earnings, and it takes $2.58 in shares to control a dollar in sales. Institutions own 79% of shares.

The company next publishes earnings on April 14. The stock goes ex-dividend in March for a quarterly payout of 12 cents per share.

Liquidity and Volatility

FITB on average trades 10.2 million shares per day and supports a wide selection of option strike prices spaced a dollar apart and with open interest running at three and four figures near the money

The front-month at-the-money bid/ask spread on puts is 4.2%.

Implied volatility stands at 23%, or the 32nd percentile of the one-year range. The high of that range came at the beginning of the 12-month period. When I toss out the outlier, the percentile becomes 59%, which is the higher end of the mid-range.

The percentile makes a difference in how I would construct a position. Anything from the 60th percentile up would, I think, best be played as a short vertical spread sold for credit. The lower end of the range, where the 32nd percentile lies, is best played as a long vertical spread bought with a debit.

Volatiliy has been zig-zagging lower since Jan. 8. I'm quandary. I trust newer data more than older, and the outlier is the oldest data in the sample. That argues for the short vertical. But the chart is bearish, and a declining stock price generally means rising volatility, which argues for the long vertical.

The solution, I think, would be to structure any trade as a synthetic short future build from options, which is volatility agnostic.

Options are pricing in confidence that 68.2% of trades will fall between $19.26 and $22.02 over the next month, for a potential gain or loss of 6.7%, and between $19.98 and $21.30 over the next week.

Contracts today are trading 30% above their five-day average volume on the call side, and at only 37% of average volume for the puts.

Decision for My Account

The more I look at the chart, the less confidence I have that wave 3 {+3} is truly complete. The decline from Jan. 22 is fairly shallow so far in the big picture. The chart has a tendency to extend. And wave 3 {+3} is shorter than wave 1 {+3}, which is a bit nervous-making. And the volatility picture is a puzzle.

There's no real reason to dislike FITB as a bear trade, beyond a certain subconscious uneasiness with the chart. I've learned over the years to take such subconscious signals seriously.

I'm going to wait on this trade. I won't place it today, but instead will put the symbol on my Watchlist. A fall below the beginning of wave 5 {+1}, at $19.76, would suggest that the downtrend is indeed underway and I would consider entering that that point


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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