Tim Bovee, Private Trader: HUM: Looming correction

Humana Inc. (HUM), like so much of the market, is in in the mature of its uptrend. I like the company's business and its financials, but it is quite expensive relative to growth, and the chart suggests that a correction looming.

The Chart

HUM is in the final leg of its rise from November 2012, which more than doubled the price. In the very near term, the count gets a bit muddled beginning last month, but my Elliott wave count puts it in the home stretch of that uptrend.

I've labeled the wave up from $63.93 beginning near the end of November 2012 as wave 2 {+1}. The waves of lesser degree that it encompasses are 5th, and final, waves down to the {-2} degree.

Click on chart to enlarge.

HUM 2 years 11 months daily bars

The end of wave 3 {+1} will usher in a correction to the downside that will take back a portion of that rise. There's no way to say how far down the price will go, but if the correction began today, a typical shallow correction would take it down to the 38.2% Fibonacci retracement level, $103.53. A steeper 61.8% correction would bring the price down to $88.40.

There is, of course, no guarantee under the Elliott rules that the correction won't be steeper, or more shallow.

Moreover, there is also no way in Elliott to set an upside target for wave 3 {+1}.

The muddled part of the count is the placement of wave 3 {-1}. The magnitude of the ensuing correction is far too shallow, and the sideways correction embedded within what I have called wave 5 {-1} is atypical, given its placement.

However, the impulse waves carrying the main trend -- the completed 1st and 3rd of the {+1} degree -- are roughly comparable in magnitude, and also in duration, the 1st having lasted for three months and the 3rd for 2-1/2 months.

The alternative count would consider wave 3 {-1} to still be underway, giving more life to the uptrend, although it would be measured in weeks, months at best.

Wave 1 {+1}, the first leg up of the rise from November 2012, lasted for a year and for months. The present wave 3 {+1} so far has run for nearly a year and seven months. A correction soon wouldn't be anomalous.

Options are pricing in confidence that 68.2% of trades will fall between $118.48 and $136.74 over the next month, for a potential gain or loss of 7.2%, and between $123.22 and $132 over the next week. I've marked the range on the chart in blue.

Odds and Yields

HUM has completed eight bull signals since wave 3 {+1} began. Five were successful, on average yielding 7.4% over 37 days. The unsuccessful trades on average lost 5.2% over 14 days.

Three of those signal occurred in the final leg of wave 3 {+1}, wave 5, Two of them were successful with an average yield of 6.4% over 23 days and one unsuccessful with a loss of 7.5% over 16 days.

The win/lose yield spread is unimpressive within wave 3 {+1}, at only 2.2%. The spread is negative in the nearer-term wave 5, at -1.2%.

This suggests that HUM is having a hard time maintaining its momentum

The Company

Humana, headquartered in Louisville, Kentucky, is one of the household names of the American health-insurance system, with nearly 20 million members enrolled in its medical benefit and specialized plans. It is the nation's third-largest health-insurance provider.

Analysts are neutral about the company's prospects, company down with perfectly balanced enthusiasm rating of zero.

The company's financials are below the growth-stock levels but are otherwise quite acceptable, with return on equity of 13% and debt amounting to only 27% of equity.

Quarterly earnings over the past three years have lacked a trend, with the peak months fluctuating more or less sideways. Earnings have surprised to the downside three times in the period, most recently in the final quarter of 2013.

The earnings yield is 5.57%, and the company pays a quarterly dividend yielding 0.88% annualized at today's prices. The 10-year U.S. Treasury note, by comparison, has a market yield of 2.61%.

Growth estimates imply a "fair" price for HUM of $83.19 per share, suggesting that shares are overpriced by 67%. I've marked that level on the chart in purple.

The stock is selling for 18 times earnings but at a steep discount to sales. It takes 46 cents in shares to control a dollar in sales.

Institutions own 94% of shares.

Humana next publishes earnings on July 30. The stock goes ex-dividend on Thursday, June 26, for a 28-cent per share payout.

Liquidity and Volatility

HUM on average trades 833,000 shares a day and supports a wide selectoin of optoins strike prices spaced a dollar apart. Open interest runs mainly to three and four figures near the money.

The front-month at-the-money bid/ask spread on calls is 12.8%, a bit wider than I like, compared to 0.5% for the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 25% and has been falling from 39% on April 7. The S&P 500 index, by comparison, has volatility of 11%.

HUM's volatility is in the 34th percentile of the one-year range, suggesting that the most successful trades will be structured as long spreads bought with a debit.

Contracts today are skewed toward puts, which are are running 11% above their five-day average volume. Calls are running at 57% below average.

Decision for My Account

I'm declining to open a bull position in HUM because its wave 3 {+1} rise is so far advanced. My judgement is that a significant correction is likely sooner rather than later, and I'd very much prefer to avoid it.

Chart aside, it's a good prospect, and I anticipate having a chance to trade it after the correction has run its course.

-- Tim Bovee, Portland, Oregon, June 23, 2014

References

My shorter-term trading rules can be read here. My longer-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 shorter-term 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.

Disclaimer

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.