Tim Bovee, Private Trader: WFT: An ambiguous trend

Update 7/11/2014: WFT never followed through on the bull signal that prompted me to open a position and on July 10 declined through its stop/loss level and below the 10-day price channel.

I've closed the position and won't place the symbol on the Roll Shelf.

WFT shars gained 0.4% over the 38 days I held the position, or 3.4% annualized. My options spreads produced a 1.8% loss on the debit, or -17.31% annualized.

Update 6/3/2014: I opened a bull position in WFT, structuring it as a bull call options spread, long the $20 puts and short the $22 puts and expiring in November. The leverage is 3.3:1.

Weatherford International Ltd. (WFT), to echo Winston Churchill's description of Soviet-era Russia, is "a riddle wrapped in a mystery inside an enigma".

The odds of success, in bull plays at least, seem to almost always be in WFT's favor. Analysts are chanting its future success like football (soccer) fans at a World Cup match.

Yet its chart is ambiguity personified. Is it bullish? Is it bearish? The answer lies on breakout levels many percentage points away.

Weatherford shows low returns on equity, carries a moderately high level of debt, and has earnings that would make a fundamentals trader cringe.

What to make of this strange chimera?

The Chart

WFT broke above its 20-day price channel on Friday with a heavy rise in volume and confirmed the bull signal the following Monday by continuing to trade above the channel.

My Elliott wave analysis places WFT in the first wave up following a zig-zag correction to the downside beginning from $39.98, the pre-recession peak set in June 2008. I've counted the correction as wave 4 {+4} in a continuing rise that may have begun before my 20-year chart began. That's tentative, of course. It could just as well, in the uptrending scenario, be wave 2 {+4}.

With the completion of wave 4 {+4} to the downside, by my count WFT has begun a climb that will eventually exceed the $49.48 peak.

Click on chart to enlarge.

WFT 20 years monthly bars (left), 3 years 4 months 3-day bars (right)

My count is an uptrending scenario, meaning that the major direction is up and downward movements are corrections.

An alternate count is possible, of course, as is so often the case in Elliott. What if the June 2008 peak was the ending of the uptrend in the {+5} degree, and all that followed is in fact a downtrend? Under that scenario, the major direction is down and upward movements are the corrections.

In the downtrending scenario, what I've called wave 3 {+4} might well be wave 5 {+4}, and that would make the present wave 4 {+4} the first wave of a major downtrend, wave 1 {+4}. The A, B and C waves in the primary count would be wave 1 {+3} plus the beginnings of wave 2 {+3}, correcting to the upside.

If the present rise exceeds $49.98, that confirms that the uptrend is still in force and the rise is properly labeled wave 5 {+4}.

If the price falters and begins a clear decline, then WFT is in a downtrend and the present wave is 1 {+4} to the downside.

Of course, my stop/loss rules will get me out of the trade far earlier if the alternate count is the correct one.

Options are pricing in confidence that 68.2% of trades will fall between $19.89 and $23.47 over the next month, for a potential gain or loss of 8.2%, and between $20.82 and $22.54 over the next week. I've marked those levels in blue on the right-hand chart.

Odds and Yields

WFT has completed six bull signals since wave 1 {+3} began from $8.84 on Nov. 15, 2012. Five were successful, on average yielding 11% over 42 days. The unsuccessful signal lost 4% over 11 days. The win/lose yield spread is an impressive 7%

Dropping down one degree, wave 5 {+2}, beginning from $13.07 on Feb. 3, 2014, had one of the successful bull signals. It gained 12.6% over 20 days.

These are excellent odds that tell me WFT rarely has whipsaws, and when it does break above its 20-day price channel, the rewards are almost always significant.

The Company

Weatherford, headquartered in Zug, Switzerland, provides equipment and services to the oil and natural gas drilling industry. It operates in more than 100 countries.

Analysts are strongly enthusiastic about WFT's prospects, collectively coming down with a positive 29% enthusiasm rating. They base their opinions on future hopes, of course, not past results. WFT's record is a bit dismal.

The company report 5% return on equity with debt amounting to 88% of equity. The return is far below what is required by my definition of the growth stock, and the return on equity is far too high.

WFT has earned money in only one of the last four quarters, giving it an earnings loss of 2.4%. The company pays no dividend.

Forward-looking earnings estimates, however, are positive, and the growth estimates suggest that WFT's "fair" price is $19.76, meaning that it is overpriced by 10%. I've marked that level in purple on the left-hand chart.

Shares are trading at a slight premium to sales. It takes $1.12 in shares to control a dollar in sales.

Institutions own 78% of shares.

Weatherford next publishes earnings on July 23.

Liquidity and Volatility

WFT on average trades 6.4 million shares a day, enough to support a wide selection of option strike prices spaced a dollar apart, with open interest running to three and four figures near the money. The front-month at-the-money bid/ask spread on calls is 4.6%, compared to 1% on the most-traded symbol on U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 29%, compared to 12% on the S&P 500 index, and has been stair-stepping lower from 39% on April 11. Volatility stands at 17th percentile, suggesting that the most successful trades will be structured as long options spread bought with a debit and expiring in November.

Options on Monday were trading slowly, with running at 33% of their five-day average volume and calls at 25% of average.

Decision for My Account

I intend to open a bull position in WFT on Tuesday, June 3 under my shorter-term rules, if upward momentum continues into the half hour before the closing bell. If momentum falters, then I'll put it on the Watchlist.

Since it is a shorter-term trade, I give less credence to the earnings and other financials than I would with a longer-term prospect. The chart is ambiguous, to be sure, but there is profit to be made if I choose correctly, and my stop/loss rules will get me out quickly if I've chosen wrong.

The most important factor in the decision were the historical odds: An 83% success rate with a high win/lose yield spread.

I'll structure the position as a bull call spread, expiring in November and sold for a debit.

-- Tim Bovee, Portland, Oregon, June 2, 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.