Thursday, March 20, 2014

HUM: Bullish on health insurance

Update 3/27/2014: I've closed my bull position in HUM after only 7 days. During the that brief period, shares lost 5%, or 258.6% annualized.

By my Elliott wave count, it is likely to be a brief correction before HUM pushes up to wave 5. Wave 1 at the same degree lasted about a month, and wave 3 about a week. 

The difficulty on this chart in assigning degrees from around the peak of wave 1 onward means that there is an alternate scenario, if I got the degrees wrong, that says HUM has completed wave 5 and is now correcting a portion of the rise from $59.92 beginning July 31, 2012 as wave  4 {+2}.

A decline below $109.21 would increase the likelihood that the alternative scenario is playing out. Better to find out while waiting on the sidelines than to be surprised while holding shares.

Click on chart to enlarge.
HUM 180 days 2-hour bars

Update 3/20/2014: I've opened a bull position in HUM, structuring it as long shares.

Humana Inc. (HUM). in contrast to most symbols showing upside momentum these days, is unambiguously in an uptrend

It is in the middle leg of a rise since 2009, although in the final phase of the longer-term rise since it hit bottom in 2000.

Barring a policy disaster, HUM has much room for profit to the upside.

The Chart

HUM's large-scale rise began June 16, 2000 from $4.75 and today's confirmation of Wednesday's bull signal brought the price to a high of $119.93, with three hours to go before the closing bell.

The Elliott wave count puts HUM in the fifth wave of that massive rise, wave 5 {+3}, beginning March 5, 2009 from $18.57.

Click on chart to enlarge.
HUM 20 years monthly bars (left), 2 years daily bars (right)
Within the fifth wave, I place HUM in the middle or third wave, 3 {+2}. This means that at the {+2} degree, HUM has a correction and a further rise before completing wave 5 {+3}.

The length of the third wave is often key to forecasting targets using Elliott wave analysis. Under the Elliott rule set, it cannot be the shortest of the three waves of the trend. In other words, the third wave must be longer than either the first wave or the fifth.

Wave 1 {+2} is $72.89 in length. So far, wave 3 {+2} is $60.01 long, and must reach $132.82 if it is to be longer than wave 1 {+2}.

There is nothing in Elliott that forbids wave 3 {+2} from ending today. It has met the minimum requirements. However, if it ends below $132.82, then the future wave 5 {+2} will need to be truncated, coming in shorter than wave 3 {+2}'s final length.

Most often in my walks through charts I've seen the third wave work out to be the longest, with an extended fifth wave being the next most common formation. I've found it rare for the first wave to be the longest of the three.

Given that experience, my expectation is that wave 3 {+2} will eventually touch $132.82, which is 13.6% above today's opening price. That's plenty of upside potential to work with.

Odds and Yields

Wave 3 {+2} to the upside has so far completed seven bull signals. Four were successful, on average yielding 8.4% over 39 days. The three failures on average lost 2.9% over 25 days.

The resulting 5.5% win/lose yield spread is quite impressive.

My take-away from the numbers is that when HUM gives a bull signal, it is more likely than not to be valid rather than a whipsaw, and the valid signals provide enough profit to be worth playing.

The Company

Humana, based in Louisville, Kentucky, is a health-insurance company. It ranks fourth in its share of the U.S. market, after Unitedhealth, Wellpoint and Kaiser Foundation.

Analysts are mildly optimistic about Humana's prospects, collectively coming in with a 5% enthusiasm rating.

The company reports return on equity of 14%, with long-term debt amounting to 28% of equity.

Earnings have been profitable for at least the last dozen quarters, but without a clear trend. There have been four downside earnings surprises in the past three years, including the most recent quarter. The other eight have surprised to the upside.

The earnings yield is 6.5%, comparable to other health and accident insurers, and the dividend yields 0.91% annualized at today's prices.

The stock is selling at 15 times earnings but at a steep discount to sales. It takes 44 cents in shares to control a dollar in sales.

Institutions own 93% of shares.

The stock goes ex-dividend on March 27 for a quarterly payout of 27 cents per share. Humana next publishes earnings on May 7.

Liquidity and Volatility

HUM on average trades 1.6 million shares a day, sufficient to support a wide selection of option strike prices spaced $5 apart, with open interest running to three and four figures near the money. The front-month at-the-money bid/ask spread on calls is 5.4%, compared to 0.8% for the S&P 500 exchange-traded fund SPY.

Implied volatility stands at 30%, compared to 14% for the S&P 500. It has been meandering sideways since Feb. 24 after falling sharply from 41% beginning Feb. 14.

Volatility stands in the 57th percentile, suggesting that long shares or an options equivalent, such as synthetic long futures, would be the most structure for a position to succeed. That percentile is just shy of the 60th, which is the lower boundary of the zone where short options spreads sold for credit tend to be the best sort of trade.

Options are pricing in confidence that 68.2 % of trades will fall between $108.30 and $129.16 over the next month, for a potential gain or loss of 8.8%, and between $113.72 and $123.74 over the next week.

Call options are trading actively today, at 61% above their five-day average volume. Puts are running at 82% of average.

Decision for My Account

I intend to open a bull position in HUM if very near term upside momentum continues into the half hour before the closing bell. If momentum falters, I shall add HUM to my Watchlist as a potential trade once momentum resumes.

I'll structure the trade as either synthetic long futures, buying calls and selling puts with the same strike and expiration, or as long shares. The options are a bit wide on the bid/ask spread, so shares may in fact be my best choice. Still thinking about it.


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 decisions for his or her own account, and take responsibility for the consequences.

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