Friday, May 2, 2014

WAG: The end is near

Walgreen Co. (WAG) is on the last leg of an uptrend that began June 20, 2012. It demonstrated that the rise still has power when the price broke above the 20-day price channel on Thursday and confirmed the bull signal by trading above that breakout level today.

My first instinct upon seeing the chart was to conclude that the end is near. But WAG is one of the symbols that just keeps on pushing to the upside, giving "near" a curiously protean definition. Yet, a close reading of the chart suggests that my first instinct may not be too far off the mark.

The Chart

The little secret that makes Elliott wave analysis possible lies in the the 3rd-wave rule, which says the 3rd wave cannot be the shortest of the three.

So figuring out what degree to assign to wave in the direction of the trend depends upon the length of the 3rd wave. If it comes in too short, then it gets counted as the 1st wave one degree lower, setting up a further series of subdivisions within the fractal structure of price movements.

Some symbols, like WAG, carry this characteristic to extremes, as, for example, in wave 3 to the upside on the right-hand chart.

The {-1} degree was quite straightforward, but the rise after wave 4 {-1} came up short, and so I had to drop down a degree in the count, labeling it as wave 1 {-2} rather than 3 {-1}.

The same phenomenon kicked in wave what I labeled as wave 1 {-3}.

Some students of Elliott would call this an extended 5th wave up from the end of wave 4 {-1}. I find it more rational, and informative, to just keep subdividing, since the Elliott rules don't require that waves be proportional to their degree.

Click on chart to enlarge.
WAG 20 years monthly bars (left), 2 years daily bars (right)
The result of all of this subdividing is that WAG is at wave 5 {-3} of 5 {-2} of 5 {-1} near the end of wave 3, which began July 20 from $28.53.

There is no rule under Elliott that limits the length of the 5th waves in that series. In all cases, at those degrees, the 3rd wave is longer than the 1st, and so no matter how long the 5th wave is, the 3rd will not come in as the shortest.

Once the 5th waves have ended at all degrees, which will happen when wave 5 {-3} concludes, wave 4 to the downside will correct a portion of the rise from $28.53 to whatever the endpoint might be (the high so far is $70.07).

Given the magnitude of the rise -- 173% so far -- I would expect the correction to be equally dramatic. But it's not required under the Elliott wave rules, and in fact the wave 4 correction could be quite shallow.

The 3rd wave at the {-3} degree last for 13 days and the 1st wave for 20 days. The present wave 5 {-3} began on April 11, so a proportion 5th wave would come to an end in the last week of May.

That's not far away, so in this case, my instinctive feeling that the end of the rise is near may prove to be correct.

However, I must in honesty recognize that WAG's upside momentum is strong enough that the rise might well be extended longer than I expect.

Odds and Yields

WAG has completed eight bull signals since wave 3 began in 2012. Six were successful, on average yielding 8% over 31 days. The two unsuccessful trades averaged losses of 3.4% over 15 days. I traded one of those signals, midway through wave 3 {-2} to the upside in October 2013. It proved to be profitable. (See my analysis at the time, "WAG: A drug store bull play")

The Company

Walgreen, headquartered in Deerfield, Illinois, operates a drugstore chain of more than 8,000 stores in the United States. About 60% of its market capitalization comes from sales of prescription drugs.

Analysts collectively give it a 9% positive enthusiasm index.

The company reports return on equity of 16%, with long-term debt amounting to 22% of equity.

Earnings tend to peak in the quarter reported in March. The most recent quarterly report showed Walgreen's earnings down from the year-ago quarter. Moreover, the report missed the consensus estimate slightly, producing a negative earnings surprise.

Over the last three years Walgreen has surprised to the upside nine times and to the downside three times.

Earnings yield 4.1% at today's prices, compared to a 2.75% yield for 10-year Treasury notes.

The dividend yield is 1.82%, amounting to 44.4% of the earnings yield.

Walgreen's earnings yield is similar to that of other drug retailers.

The stock is selling for 24 times earnings but at a discount to sales. It takes 89 cents in shares to control a dollar in sales.

Institutions own 62% of shares.

Walgreen next publishes earnings on June 24. The stock goes ex-dividend May 19 for a quarterly payout of 31.5 cents per share.

Liquidity and Volatility

WAG on average trades 5.5 million shares a day and supports a moderate selection of option strike prices spaced $2.50 apart near the money, with strike prices running to three figures generally.

The front-month at-the-money bid/ask spread on calls is relatively narrow, at 3.2%, compared to 0.6% for the most-traded symbol on the U.S. exchanges, the fund SPY.

Implied volatility stands at 25%. It has began declining since April 10, when it hit 30%.

Volatility stands in the 53rd percentile of its one-year range, suggesting that a position structured as long shares or an equivalent synthetic position built from options would have the best chance of success. Forward-looking implied volatility is 3% below historical volatility.

Options are pricing in confidence that 68.2% of trades will fall between $64.16 and $74.18 over the next month, for a potential gain or loss of 7.3%, and between $66.76 and $71.58 over the next week.

Contracts are trading actively today, with calls running 53% above their five-day average volume and puts at 42% above average.

Decision for My Account

I don't intend to open a bull position in WAG. My chart analysis convinces me that the symbol will swing into a downside correction sometime within the next month. I'd prefer to have a longer time horizon for the uptrend.

WAG has surprised me before, and might well surprise me again by continuing to rise. At this point, however, I judge the weight of the evidence to be in favor of a correction beginning soon.

And yet... And yet....

My trading rules won't allow for an ambiguous play like WAG, and I have this nagging feeling that they should, that there ought to be a way to play this ambiguity rationally and profitably. Note to self: Must work on this.


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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