Tuesday, April 22, 2014

MU: Exuberance amid a powerful recovery

Update 8/4/2014: The decline of MU has continued, and it closed below its 10-day price channel on July 31 and confirmed the signal by trading below that level the next day. 

My handling of MU was delayed by a travel day, and when I returned to it on Aug. 4, I discovered that although MU remains below the July 31 signal level, it has attained higher highs and higher lows for two days straight.

This sets up a perfect opportunity for the Wishful Thinking Machine that lives within our brains to take charge, muttering, "Sure, rules are rules, but look at that uptrend!"

Honestly, I've always found it hard to resist the Sirens' call of the Wishful Thinking Machine. That's why I moved to a strict rule-based system of trading. This is a chart, if ever one there were, that gives a private trader a chance to stand strong.

Click on chart to enlarge.
MU 5 days 5-minute bars
I've removed MU from the Roll Shelf. The trade was quite successful. MU shares gained 23% over the 98 day life of the position, or 85.5% annualized. The options I used for the trade produced a 43.5% yield on debit, or 162% annualized.

Update 7/29/2014: MU fell below its stop/loss level of $33.01 on July 28 and confirmed the signal by trading below that level the next day. I've closed my bull position.

MU remains within the 10-day price channel and so will be placed on the Roll Shelf for further consideration if it resumes its rise. My practice is to not calculate profit and loss until a roll series is complete.

The chart suggests that MU has completed the first wave up in the rise that began in April 2014 and is now correcting a portion of that rise. There is no way to say for certain whether the correction will be shallow or deep. However, wave 2 {-1} to the downside is a second wave, and they often tend toward depth.

The first wave, 1 {-1}, ran for 96 days. If the 2nd-wave correction has a similar duration -- not guaranteed -- it would last until October.

Click on chart to enlarge.
MU 2 years 2-day bars (left), 3 months 3 weeks 1-hour bars (right)
Update 4/22/2014: I've opened a bull position in MU, structuring it as bull call spreads, long the $25 calls and short the $28 calls, expiring in October and bought with a debit.

Micron Technology Inc. (MU), like most of the market, is in the midst of an uptrend that began with the market collapse that marked the Great Recession. Unlike many, this symbol is in the middle range of its uptrend rather than nearing its end.

MU broke above its 20-day price channel on Monday, sending a bull signal that was confirmed as it traded still higher today.

The chart, however, does present some pitfalls. The most recent leg of the uptrend began in October 2011, and the internal structure of the present portion of rise makes it difficult to analyze. I have no doubt that MU is in the middle leg of it rise from 2011, but I'm less certain how far it has progressed along the middle leg, which began in October 2012.

On the other hand, the earnings record tells a story of a powerful recovery after several years in the doldrums and the magnitude of the rise from 2012 reflects that story.

The Chart

MU is a tech stock, and a glance at the chart alone would confirm that fact. It peaked in 2000 at $97.50 and has since been correcting, or possibly trending, to the downside.

I've counted this chart, using Elliott wave analysis, as a three-wave correction at the {+4} degree, with MU presently in B {+4} wave to the upside, and one degree lower in wave C {+3}, also to the upside.

C waves divide into five waves of lower degree, and MU is presently in wave 3 {+3}.

Click on chart to enlarge.
MU 15 years weekly bars (left), 2 years daily bars (right)
However, if the 2000 peak has been followed by a downtrend at the {+4} degree, then my A {+4} was in fact 1 {+4} ending in 2008, and the present B {+4} is instead 2 {+4} to the upside. Within 2 {+4} under this alternative scenario, MU is present in wave 3 {+2} of wave 3 {+3} to the upside.

This is all very long-term structure and yet it potentially has an immediate bearing on the present trading decision. B waves tend to be weak and so B {+4} is less likely to extend much higher. Under the alternative scenario, 3rd waves are powerhouses, and wave 3 {+4} is more likely to extend higher to the upside.

Either scenario fits the Elliott wave counting rules and I am unable to choose between them.

I turn now to wave 3 {+2} to the upside, the present uptrend that began Oct. 24, 2012 from $5.16. By my count internally MU is within the 5th (and final) wave of wave 3 {+1}, the middle wave of 3 {+2}.

The peaks and retracements within wave 3 {+2} are poorly differentiated by magnitude. It's impossible to tell with any certainty what degree a wave is in. So my count is at best a plausible scenario. I'm fairly confident that MU isn't in wave 1 {+1}, but it might well be in 5 {+1}, nearing the end of its span.

Again, it's impossible to say for sure which count is correct.

Under such circumstances, the trader either declines the trade or takes it, relying on exit rules and hedging to keep a correction from causing too much damage.
I've found that this sort of poor differentiation often accompanies a stock that is prone to trader exuberance, whether rational or irrational remains to be seen. It can be the sign of an uptrend so powerful that it can barely spare a nod toward the necessary correction that accompany its rise.

Odds and Yields

MU has completed six bull signals since wave 3 {+2} began in October 2012. Five were successful, on average yielding 21.9% over 50 days. The one failure lost 7.2% over 15 days.

The resulting win/lose yield spread is quite high, at 14.7%.

These numbers tell me that MU hasn't been prone to whipsaws on bull plays and gets sufficient return to overcome a great deal of risk.

The Company

Micron Technology, headquartered in Boise, Idaho, makes semiconductor devices, not the CPUs so much as the workhorses of computing, the chips that enable the central processor to function. The company's product line includes various sorts of flash memory, sensors and other chips for use in consumer and industrial products.

Analysts are nearly neutral in their collective judgment of Micron's prospects, coming in with a negative 5% enthusiasm rating.

The company reports return on equity of 23%, more than double the 10% reported the quarter before, with debt amounting to 43% of equity. Micron therefore falls outside my rule of thumb for a growth stock, which I define as return of 20% or more with debt at 10% or less.

Micron went through a period of seven consecutive losing quarters from late 2011 to March 2013. It returned to profitability thereafter, recording four quarters of accelerating earnings, three of which surprised to the upside. All in all, the record points to a strong bullish recovery from a difficult few years.

The earnings yield is 9.22%, greater than 89% of other semiconductor companies. Micron pays no dividend.

The stock is selling at 11 times earnings and also at a premium to sales. It takes $1.92 in shares to control a dollar in sales.

Institutions control 89% of shares.

Micron next publishes earnings on June 16.

Liquidity and Volatility

MU on average trades 34.3 million shares a day and supports a wide selection of option strike prices spaced a dollar apart. The front-month at-the-money bid/ask spread on calls is quite narrow, at 1.8%, compared to 0.4% for the most-traded symbol on the markets, the exchange-traded fund SPY, which tracks the S&P 500.

Implied volatility stands at 13% and has been trending in a shallow decline since peaking at 77% on March 14. That level puts MU's volatility in the 13th percentile of the one-year range, suggesting that long options spreads, such as bull calls spreads, bought with a debit would have the greater chance of success. Implied volatility is 6% above historical volatility.

The S&P 500, by contrast, has implied volatility of 13%, less than a third of MU's implied volatility.

Options are pricing in confidence that 68.2% of trades will fall between $23.04 and $29.28 over the next month, for a potential gain or loss of 11.9%, and between $24.66 and $27.66 over the next week.

Contracts are trading actively today with a slight skew toward puts, which are running at a bit more than double their five-day average volume. Calls are running at 77% of average volume.

Decision for My Account

I intend to open a bull position in MU. The chart has its pitfalls, but nothing too terrible. The fundamentals carry more weight with MU than is usual in my trading, given the accelerating earnings after the company has recovered from a bad patch.

However, I want to ensure that it is a hedged position, with limited loss potential. Given the relatively low implied volatility, I'll structure the position as bull call vertical spreads, bought with a debit and expiring in October.


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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