Friday, March 14, 2014

SDRL: A broken narrative

Update 3/31/2014: SDRL broke above its 10-day price channel on Friday, March 28, and confirmed the signal today by trading still higher. 

It has been sitting on the Watchlist since March 14 waiting to see whether it was in fact an acceptable bear play.  Under my rules, the break beyond the price channel in the direction opposite the proposed trade means that I must remove SDRL from the Watchlist.

I premised any trade based on SDRL's holding below $34.57, an earlier support level. Friday's close was $34.89, so SDRL has failed to meet the criteria of my chart analysis.

The symbol remains in a downtrend from $48.09 beginning Sept. 19, 2013.

Seadrill Ltd. (SDRL) broke below its 20-day price channel at $34.06 on Thursday, sending a bear signal that was confirmed in trading Friday.

SDRL began trading on the exchanges in April 2010, and so the chart has a shorter history than that of many major companies.

To understand the SDRL chart, we must decide on the nature of the $48.09 peak attained last September and the prior support level of $34.57 set last April.

The most straightforward way of analyzing the chart makes $48.09 an interim high within an ongoing uptrend. If that is correct, then the $34.57 support should hold.

Every chart is a narrative, and like all narratives, each must make logical sense according to whatever system of analysis a trader is using.

Under the Elliott wave framing that I use, the break below support is an inconsistency in SDRL's plotline, the equivalent of James Bond giving up his Walther PPK handgun, his 60 custom-made cigarettes a day and his dry martinis, and teaming up with Auric Goldfinger and Pussy Galore to open a trading house specializing in environmentally friendly corporations, with the bulk of the profits going to the Bill and Melinda Gates Foundation to improve health and reduce poverty in Africa.

It would be a nonsensical repudiation of everything Bond stands for, a broken narrative.

The Chart

The straightforward Elliott wave count labels the Sept. 19, 2013 peak of $48.09 as wave 3 {+1}, the middle wave of a rise from $17.81 beginning July 1, 2010.

That worked fine until Feb. 18, when SDRL broken below that support level. The Elliott wave rules dictate that a 4th wave cannot move beyond the start of the preceding 3rd wave of the same degree.

Some Ellioticians allow such a move by 4th waves under certain limited circumstances, but the exceptions don't apply in this case.

Click on chart to enlarge.
SDRL 4 years 2-day bars (left), 1 year daily bars (right)
If wave 3 {+1} were instead the end of a 5th wave, then break below support would be allowed under Elliott. If what I've labeled as wave 1 {+1}, which ended Oct. 18, 2012 at $41.95, and instead moved above the preceding wave 1 {+2}'s terminus of $42.34, then the count might also work.

But those are counterfactuals. The reality of the chart is that in this one regard it simply fails to fit into the Elliott wave framing.

The decline from the September 2013 peak count properly, putting SDRL in the final wave down of the first wave down of its wave 4 {+1} correction. Although, if the September peak indeed ended the uptrend, then SDRL has been in wave 1 {+1} to the downside since September.

Either count has further downside potential.

Odds and Yields

SDRL has completed three bear signals since September 2013 peak. Two have been successful, yielding on average 6.8% over 26 days. The failing trade lost 3.9% over 14 days. The resulting win/lose yield spread is 2.9%, not huge but not insignificant, either.

The Company

Seadrill, headquartered in Hamilton, Bermuda, provies offshore drilling services to the oild and gas industry. Managed from Norway, Seadrill has operations in Europe, Africa, Asia and Americas.

Analysts collectively come down at a negative 33% enthusiasm rating for Seadrill's prospects.

The company reports return on equity of 16%, with debt amounting to 38% more than equity.

Earnings stumbled in late 2012, recovered the first two quarters of 2013, and then stumped again the last two quarters.

Earnings have surprised six times in the last three, most recently in the last two quarters. It has surprised to the upside six times, as well.

The earnings yield is 14.78%, greater than 87% of other oil well services and equipment companies. The stock sells at a steep premium to sales. It takes $3.15 in shares to control a dollar in sales.

The dividend yield is 11.73% annualized at today's prices, which amounts to 79% of the earnings yield, a very high level.

Institutions own 36% of shares. Seadrill next publishes earnings on May 30. The stock goes ex-dividend in July for a quarterly payout of 98 cents.

Liquidity and Volatility

SDRL on average trades 4.7 million shares a day, sufficient to support a wide range of option strike prices spaced a dollar apart, with open interest running to five figures near the money.

The front-month at-the-money bid/ask spread on puts is 11.5%, which is 23 times the spread on the S&P exchange-traded fund SPY. That's quite wide.

Implied volatility stands at 27%, having fallen steeply from a one-year high of 32% since Feb. 20.

Volatility is in the 69th percentile of the annual range, suggesting the an options spread sold for credit, such as a bear call spread, would have the best chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $30.81 and $35.97 over the next month, for a potential gain or loss of 7.7%, and between $32.15 and $34.63 over the next week.

Contracts today are trading actively, with calls at more than double their five-day average volume and puts at 65% above average volume.

Decision for My Account

The ambiguity of the Elliott wave count is the main blemish on SDRL as a bear play. Another is that it pays a high dividend, which gives it a bullish bias, because high dividends means more long-term investors and a greater tendency to hang on to stock rather than selling.

Friday's opening price is 2.9% below the broken support level of $34.57. If the price remains below that level, then SDRL is in a downtrend. If it quickly retreats above that level, as it did in February, then perhaps the broken support is an anomaly, indicating a 100% correction of the rise from April to September 2013.

I don't intend to trade SDRL today, but shall instead put it on the Watchlist to see how the Elliott wave count develops.


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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