Tim Bovee, Private Trader: MON: Bearish on new-tech agribusiness

Update 9/19/2014: MON reversed direction, confirming a close above its stop/loss level, and I've closed my bear position for a loss. I'm moving the symbol the Roll Shelf, where it will remain pending a fresh break below the 20-day price channel. If it confirms a close above the 10-day channel, then I'll remove it from the shelf and calculate results.

Click on chart to enlarge.

MON 4 months daily bars

By my analysis, MON has completed a five-wave decline, reversing in a move that will take back part of the downtrend that began on June 25 from $128.79 and that carried the price down 13.8%.

Update 9/5/2014: I've opened a bear position in MON, structuring it as a bear put options spread, long the $115 puts and short the $110 puts, expiring in January and bought with a debit. Leverage is 9:1.

Although MON at entry was up intra-day, it had begun a small downward movement three hours before the closing bell that was sufficient momentum for me to make the trade.

Monsanto Co. (MON) makes headlines often for its new-tech innovations in agriculture, such as genetically modified foods. The news, however, is as often in protest against the innovations as in praise of their ingenuity. Despite the whiz-bang nature of its business, Monsanto's chart shows the stock to be an all-natural genetically unmodified decline.

The Chart

As is so often the case, placing MON within an Elliott wave requires us to make difficult decisions about the degree that we're counting. At issue, specifically, are waves 1 through 5 within wave 4 {+1} to the downside.

Click on chart to enlarge.

MON 7 years 2 months weekly bars (left), 14 months daily bars (right)

If I count them at the base degree, as I have as my primary analysis, then the wave 4 {+1} downward correction is in its stage. If I count them down a degree, as waves 1 {-1} through 5{-1}, as I have in my alternate count, then wave 4 {+1} is in only the 1st wave of five, and has much more potential to the downside.

The two impulse waves to the upside in the {+1} degree lasted four months for the 1st wave and seven months for the 3rd wave.

The counter-trend correction, wave 2 {+1}, was much shorter, lasting only 32 days. It's not at all unusual for counter-trend waves to last a shorter time than their trending cousins. Most of the energy in the market is pushing behind the trend.

The present counter-trend wave, 4 {+1}, has so far lasted for 72 days, well within the range that is consistent with other waves in the {+1} degree.

The present wave 5 to the downside must move below $109.40, the end of wave 2 in the series. And wave 4 {+1} must stop short of $104.08, the end of wave 2 {+1}.

That gives a target range, with a minimum potential of 3.7% below today's opening and a maximum of 8.4%. Not bad, especially with leverage.

Odds and Yields

MON has completed one bear signal since wave 4 {+1} to the downside began on June 25. It was successful, yielding 2.3% over 19 days.

The Company

Monsanto, headquartered in St. Louis, Missouri, makes chemicals and biotechnology products for agriculture. It is the leading producer of what critics call "frankenfoods", the genetically engineered crops that enable growers to increase yields and lower losses to insects.

Analysts are wildly optimistic about Monsanto's prospects, collectively coming down at a 50% enthusiasm rating. Zacks Investment Research, the service I use to speed my fundamental analysis, is bearish on the company.

The company's genetically modified products are controversial, making it subject to news and regulatory shock. On the other hand, when have we ever foresaken useful technology? I suspect that GM foods are the future and my 4-year-old grand-daughter, after she grows up, will pluck them from the grocery shelves without a second's hesitation.

Monsanto reports return on equity of 19% with debt running at 21% of equity, both reasonable levels.

The company has reported three losing quarters out of the last 12, most recently in the 4th quarter of 2013. Business tends to peak in the 2nd quarter, in lockstep with the planting season, and that quarter has come in higher than its year-ago counterpart in the last three years.

The earnings yield is 4.35%, compared to 2.44% on the 10-year U.S. Treasury notes. The dividend yields 1.72% annualized at today's prices.

Growth estimates, combined with the dividend, imply a "fair" price of $82.05 per share, meaning that MON is over-valued by 39%. The stock is selling for 23 times earnings. I've marked that price level in purple on the left-hand chart.

MON is also selling at a steep premium to sales. It takes $3.86 in shares to control a dollar in sales.

Since MON is a potential bear play, the relatively high price of the stock can be seen a buttressing a bear position, as cooler heads prevail among traders. On the other hand, it means that a bear position is running contrary to the conventional wisdom, never a comfortable position.

Institutions own 85% of shares.

Monsanto next publishes earnings on Oct. 8. The stock goes ex-dividend on Oct. 8 for a quarterly payout of 49 cents per share.

Liquidity and Volatility

MON on average trades 3.3 million shares a day nd supports a wide selection of option strike prices spaced $5 apart, with open interest running from three to five figures near the money.

The front-month at-the-money bid/ask spread on puts is 5.6%, compared to 1.5% for the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 19%, compared to 12% for the S&P 500 index. It has been on the rise since Aug. 18, when it hit 16%.

MON's volatility stands in the 33% percentile of the one-year range. Trades structured as net long option spreads bought with a debit will have the best chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $107.96 and $120.72 over the next month, for a potential gain or loss of 5.6%, and between $111.28 and $117.40 over the next week.

I've marked the month range on the right-hand chart in blue.

Contracts are trading briskly today with a noted skew toward puts, which are runing at double their five-day average volume. Calls ar running at 28% above average.

Decision for My Account

I intend to open a bear position on MON. True, the chart places MON in a counter-trend correction, but I see sufficient downside potential to make the play attractive. The fact that shares have been bid up to such high levels is also a positive, as is the liquidity of the options, which will make possible a leveraged trade.

Four hours into trading, MON has developed a strong intra-day move to the upside. If that very short term uptrend continues, then I'll defer opening a position until another day, placing MON on the Watchlist.

-- Tim Bovee, Portland, Oregon, Sept. 5, 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.