Tuesday, March 18, 2014

VRSN: An unconvincing bear signal

VeriSign Inc. (VRSN) broke below its 20-day price channel on Monday and traded below that level on Tuesday, confirming the bear signal. The evidence for a robust downtrend is unconvincing on several levels.

The chart shows signs that VRSN remains in a bull trend, which would make Monday's bear signal a contrarian event. Moreover, the breakout itself is hard to take seriously under Turtle trading rules because of the quantum nature of price channel boundaries.

Explaining that latter claim requires a walk in the weeds.

Anyone who has worked with indicators based on averages, such as moving averages or even Bollinger bands, are used to seeing incremental changes. The indicator changes, step by step, but sharp movements are rare. That's what averages are for, after all, to smooth out the outliers.

Price channel boundaries, which are based on a time span rather than averaging, often move in sudden leaps, as when, for example, an old decline that pushed the boundary down significantly moves beyond 20 days into history and the lower boundary jumps back up.

That's what happened to VRSN. The 20-day channel's lower boundary was $51.41 on Friday, the daily low of Feb. 13. The stock took a large drop on Monday, closing 5.8% below Friday's close.

Friday's close of $51.68 would not have produced a bear a signal had it occurred a day earlier. But by Monday, the Feb. 13 low had moved beyond the 20-day boundary, sending the price channel boundary soaring to $53.90, converting a non-signal into a signal.

It's easier to see on a chart. Note the sudden upward spike in the lower channel on Friday.

Click on chart to enlarge.
VRSN 3 months daily bars
I would give the signal more credence had VRSN traded still lower on Tuesday, but instead it has risen intraday by 2.2%.

The Chart

The big event in VRSN's career was the collapse of the tech bubble in 2000, which by 2002 had carried the price form its peak of $258.50 down to $3.92. Everything that has followed for the past dozen years has been VRSN attempting to climb out of that very deep hole.

Elliott wave analysis shows that VRSN remains in the middle portion of that climb, an uptrend that began from $16.23 on Nov. 21, 2008, and at a lower degree, within the final portion of the middle portion of the rise from 2008, beginning Oct. 4, 2011.

Click on chart to enlarge.
VRSN 6 years 3-day bars (left), 2 years daily bars (right
The 2011 rise is entered its final stages with the reversal on Jan. 16 from the $62.92 peak, which I've labeled wave 3 {+1}.

The present downward move, then is wave 4 {+1}, a three-wave downtrend that has corrected nearly half of wave 3 {+1}, which began June 24, 2013 from $43.28.

I've counted wave 4 {+1}, now two months old, as being in its third and final stage, wave C. That is not at all disproportional to the other waves of the {+1} degree. The prior downside correction, for example, wave 2 {+1}, took about five weeks to complete.

However, my wave C could just as well be wave 3 {-1} of a longer-lasting wave A, the first leg of the correction. Only time will tell which count is correct.

Wave C has moved below the end of wave A, which is the minimum requirement for it to complete its run. It could decline further, but there is a limit.

Under the Elliott rules, wave 4 {+1} cannot travel below $43.28, and that once wave 4 {+1} is complete, wave 5 {+1} to the upside will carry the price above $62.96.

That means that the maximum downside potential is 16.3% (but typically less), and the minimum upside potential is 21.8% (but typically more). There is money to be made in either direction, but the chart favors the bulls.

Odds and Yields

VRSN has completed three bear signals since wave 5 {+2} began from $32.81 on Nov. 30, 2012. Two were successful, on average yielding 2.8% over 27 days. The unsuccessful trade lost 4.5% over nine days. That heavy loss pushed the win/lose yield spread into negative territory, at -1.7%.

One of the winning bear signals was in wave 3 {+1}, which began last June and ended in January. It yielded 4.7% over 23 days.

The odds don't give much promise of success. VRSN has been so bullish over the past years that it has little in the way of bearish history to help me make a trading decision.

The Company

VeriSign, headquartered in Reston, Virginia, runs two of the 13 nameservers that allow the Internet to function. It is the core registry for the .com top-level domain. It also provides security services that ensure companies can continue to function on the 'net, even in the face of attacks.

The sharp decline at the start of the week came in response to an announcement that the U.S. government plans to relinquish control of the domain name system that account for 96% of VeriSign's market capitalization, although the company says such a move wouldn't impact its business. See the Bloomberg News story by Pui-Wing Tam here.

The handful of analysts following the company aren't optimistic about its prospects, coming down collectively at a negative 20% enthusiasm rating (a tally made prior to the government's announcement).

The company reports return on equity of 49% with no long-term debt.

Earnings have remained stable, and profitable, over the past five quarters. VeriSign has surprised to the downside five times in the past three years, including the most recent quarter, and to the upside seven times.

The earnings yield is 6.82%, higher than 72% of other software and programming companies. The company pays no dividend.

The stock is selling at nearly 14 times earnings, and also at a premium to sales. It takes $7.16 in shares to control a dollar in sales.

Institutions own nearly all of the shares. VeriSign next publishes earnings on April 21.

Liquidity and Volatility

VRSN on average trades 2.3 million shares a day. Note that Monday's sharp decline came on volume nearly five times the average, at 10.8 million shares.

The options grid covers a moderate selection of 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 puts is 3.4%, compared to 0.3% for the S&P 500 exchange-traded fund SPY.

Implied volatility stands at 29%, compared to 14% for SPY. It has been on the rise from 24% from Feb. 21, although it dropped on Tuesday.

Volatility stands in the 63rd percentile, suggesting that short options spreads sold for credit have the biggest chance of success. That level is just three points above the neutral range.

Options are pricing in confidence that 68.2% of trades will fall between $48.11 and $56.95 over the next month, for a potential gain or loss of 8.4%, and between $50.41 and $54.65 over the next week.

Contracts are trading near normal levels today, with puts at 85% of their five-day average volume and calls at the average.

Decision for My Account

There are many reasons to dislike VRSN as a bear play.

The high volume on Monday means there are a lot of players who panicked out just waiting to get back in if there is a sign that the bad news isn't so bad.

The $5 spread on the options strikes gives less granularity in constructing a hedged position.

Most damning is the fact that Mondays decline put wave C below the end of wave A, fulfilling the minimum requirement for declaring wave 4 {+1} to be complete.

For those reasons, I'm declining to take a bear position in VRSN based on this signal.


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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