Tim Bovee, Private Trader: GM: Crossing the Gap

Update 8/22/2014: This 8/20 update is an example of why one must be especially careful about Trading While Jet-Lagged (TWJ being the private trader equivalent of DWI).

First, GM moved above the 10-day price channel, not the 20-day. Second, a move above that channel removes the possibility of rolling forward to a new position. So GM should never have found a spot on the Roll Shelf. And third, no roll, therefore, time to calculate profit and loss.

GM shares prices fell by 1.3% over the 26-day life of the position, or down 18.455 annualized. The options spread produced a positive 6.3% yield on debit, or +87.7% annualized.

An update of the chart since the July 2 peak shows that GM remains in a downtrend and is engaged in a wave 4 counter-trend correction to the upside. The {-1} degree count within wave 4 may in fact be at the {-2} degree. Whatever, it shows that there is still some near-term upside potential before the decline resumes.

Click on chart to enlarge.

GM 60 days 2-hour bars

Update 8/20/2014: GM closed above its ~~20-day~~ 10-day price channel and I've exited my bear position, moving the symbol onto the Roll Shelf. I'll roll back into a bear position if the price closes below the 20-day price channel. As is my usual practice, I'll calculate profit and loss only when the entire roll series is complete.

Once upon a time, there was an auto manufacturer that turned out vehicles by the millions for the people of The Land. It met competition bravely, although not always with great success. But in general it thrived, providing jobs and livelihoods for its folk.

Then one day dark clouds moved over The Land, as the Forces of Greed, far away in the Evil Castle of Wall Street, cast lightning bolts at the Forces of Prosperity and opened up a gap in the in the center of the World, the massive rift in the fabric of existence known to the Norse Gods as the Ginnungu Gap.

Many companies and people failed to survive the Ginnungu Gap. Many found it impossible to cross to the other side.

But the auto manufacturer was fortunate. A Guardian Angel reached out a hand and lifted Old GM over the Ginnungu Gap, gently placing it again on a grassy spot in Detroit, where it could continue turning out vehicles and creating jobs and livelihoods.

The manufacturer hoped that with the crossing, it had been reborn, transformed into a smarter and nimbler New GM. Whether indeed it has had achieved a rebirth in crossing the gap remains an open question.

General Motor Corp. (GM) has been something of an epic figure for the past five years, from the day it quit trading after the U.S. government assumed control of its fate. To me it feels like a tale from Norse mythology, or a summer sword-and-sorcery adventure film.

GM broke below its 20-day price channel on Thursday after the company announced earnings that were below analysts' expectations.

The Chart

The chart suggests that New GM is in the midst of a downward correction of some sort, with the evidence form Elliott wave analysis pointing toward continued decline.

Click on chart to enlarge.

GM 20 years monthly bars (left), 4 years 2-day bars (right)

The waves count best as an A-B-C decline, based primarily on the magnitude of the wave B decline from Feb. 17, 2012 to July 25, 2012, marked with a red arrow in the right-hand chart. It sets up the rise from Dec. 19, 2011 as a three-wave movement within wave B {+1}.

A move above $43.20, the final peak before the 2009 crash, would draw credence away from my framing of the chart.

If my framing is correct, then I would expect GM to fall below the $31.70 level of April 11 that marked the end of wave 1, perhaps significantly below.

The gap in trading that marked the government intervention appears to have not caused a decisive break in GM's progress through the Elliott wave count.

I've framed the New GM portion of the chart as a downward correction within an uptrend of higher degree. If it is indeed a downtrend following a completed uptrend, then the downside potential is all the greater.

Odds and Yields

GM has completed two bear signals since it resumed trading on Nov. 18, 2010.

One was successful yielding 10% over 40 days. The other was unsuccessful, losing 5.2% over 19 days.

The resulting win/lose yield spread is quite respectable, at 4.8%, mitigating the lack of better than even odds of success.

The Company

General Motors is too well known to spend much time describing its business. Headquartered in Detroit Michigan, GM produces vehicles in 37 countries under 10 brands.

Ranked by production, in 2012 it was the largest U.S. automaker and second-largest globally, after Toyota.

Analysts are positive in their assessment of GM's future prospects, giving it a 38% enthusiasm rating.

GM reports return on equity of 16%, with debt amounting to 58% of equity.

Earnings in each of the first two quarters of 2014 are well below their year-ago and two-year-ago counterparts. In the last three years GM has surprised to the downside four times, most recently in Thursday's 2nd quarter 2014 report and in the 4th quarter of 2013. All other quarters have surprised to the upside.

GM's earnings yield is 3.5%, compared to a 2.47% yield on the 10-year U.S. Treasury notes. The dividend yield is 3.5%, or 0.98% of earnings.

Estimated earnings growth combined with dividends implies a fair price of $48.66. By that estimate, GM is underpriced by 28%. I've marked that price on the left-hand chart in purple.

The stock is selling for nearly 29 times earnings but at a steep discount to sales. It takes only 37 cents in shares to control a dollar in earnings.

Institutions own 67% of shares.

GM next publishes earnings on Oct. 28. The stock goes ex-dividend in September for a quarterly payout of 30 cents per share.

Liquidity and Volatility

GM on average trades 12.7 million shares per day and supports a wide selection of option strike prices spaced a dollar apart, with open interest running to the three- and four-figures. The front-month at-the-money bid/ask spread on puts is 2.7%, compared to 0.4% for the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 26% and has been trending sideways since July 8, compared with 13% for the S&P 500.

GM's volatility is at the 26th percentile of its one-year range, suggesting that option spreads bought with a debit have the best chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $32.36 and $37.60 over the next month, for a potential gain or loss of 7.5%, and between $33.72 and $36.24 over the next week.

Contracts today are skewed slightly toward puts, which are running at 12% above their five-day average volume. Calls are 2% above their average volume.

Decision for My Account

There are ambiguities on this chart, as I've discussed above. I have enough confidence in the near-term count that I'm willing to take the risk.

I've opened a bear position in GM, structuring it as a bear put spread, long the $36 puts and short the $33 puts, bought with a debit and expiring in December.

The postioned is leveraged 5:1.

Note

I've labeled the break in trading from June 2009 to November 2010 as the Ginnungu Gap, a tribute to the Norse creation account, the Gylfaginning and to the existential event that closes James Blish's Cities in Flight tetralogy.

-- Tim Bovee, Portland, Oregon, July 25, 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.

From time to time 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.