Friday, December 5, 2014

TCK: A bear's true love

Update 1/17/2015: My short options spreads for January expired out-the-money and so without value, providing maximum profit. The position had been rolled forward from the previous position, which lasted from Dec. 5, 2014 to Dec. 11, 2014. The second position in the series ran from Dec. 11, 2014 to Jan. 16, 2015.

During the 21-day lifespan of the positions, shares declined by -10.8%, for a -187.8% annual rate.

The options produced a 94.2% yield on debit, or a 1,638.8% annual rate.

Update 12/11/2014: My short options spread on TCK had declined to just a couple of cents in value, so close to maximum profit that it wasn't worth assuming further time risk. I've closed the position and rolled it forward from the December options to the January options.

The stock was priced at $14.74 when I entered on Dec. 5. Six days later, it had dropped to $11.91. It turned out to be a successful trade.

The new position is short the $13 calls and long the $14 calls, sold for a credit and expiring Jan. 15. The short leg is $2 lower than was the original position's. 

The risk/reward ratio is 4.2:1, a bit higher than I prefer. That is, I broke my rules and fudged. The reason for the fudge was to obtain a higher probability of expiring out of the money: 75.4%. The alternative would have brought the probability down to a bit below 60%. I thought it was a reasonable trade-off.

As is my usual practice, I won't calculate profit and loss on each position within a series, waiting instead until no further trades are possible.

Teck Resources Ltd. (TCK) is in the old-style business of mining with low return on equity, declining earnings and a long-running downtrend on its chart. What's not to like? Teck is a bear's true love and object of affection.

The Chart

TCK hit a post-recession peak of $65.37 in January 2011, and it has been all downhill ever since. As the recession took hold, TCK's price had collapsed from $84.07 down to a November 2008 low of $2.60.

At the largest degrees, the Elliott wave analysis leaves room for several interpretations. Absent evidence to the contrary, I've chosen to consider the present movement to the downside as  countertrend correction within an uptrend, of which the Jan. 2011 peak is wave 1 {+3} and the present movement is wave A {+2} within wave 2 {+3}.

Based on what is known so far, TCK could just as easily be in a downtrend, with the 2011 peak standing as wave A {+3} and the present movement being wave A {+2} within B {+3}.

There is no way to choose between the two. Flip a coin.

Click on chart to enlarge.
TCK 6 years 8 months weekly bars (left), 2 years daily bars (right)
At the smaller degrees more relevant to a trade, TCK has been in the 5th and final wave of the middle wave of wave A {+2}, since Oct. 2013, when it peaked at $30.02. The decline has taken away about half of TCK's value at the time.

My count shows that within wave 5, TCK is in the final wave (5 {-2}) of its middle wave (3 {-1}).

For a shorter term trade,  the question is how long will wave 5 {-2} prove to be. The 4th wave to the upside that follows wave 3 {-1} will usher in  significant correction, taking back  portion of the decline from $26.44, a level hit in January.

My judgment is that wave 5 {-2} still has some distance to go. There's no minimum requirement for length, except for a move beyond the end of the preceding 3rd wave, but in term so magnitude, it is still quite small compared to the 3rd and 1st waves of the same degree.

Odds and Yields

TCK has completed four breakouts since wave 5 began in October 2013. Three were successful, on average yielding 11.9% over 59 days. The unsuccessful trade lost 3.1% over 15 days, on average.

The Company

Teck Resources, headquartered in Vancouver, British Columbia, is Canada's largest diversified metals and mining company, extracting a wide range of materials including steelmaking coal, copper, zinc and fossil fuels.

Perhaps it is intrinsic to the nature of extractive businesses, but analyst enthusiasm is low, with a negative 38% enthusiasm rating.

The company reports return on equity of 3%, with debt running at 43% of equity.

Earnings have been profitable in all of the past 12 quarters but has been generally declining for the past three yeas.

Seven quarters have produced upside surprises and the rest surprised to the downside. The most recent of the downside surprise was in the 1st quarter of this  year.

The earnings yield is 4.8%, compared to a 2.32% yield on 10-year U.S. Treasury notes. The dividend yield is 6.1% annualized at today’s prices.

The "fair" price implied by earnings growth estimates is $13.34 per share, compared to the market price of $14.78 per share. The market premium is 11% above the implied price.

The stock is selling at 21 times earnings and also at a small premium to sales. It takes $1.11 in shares to control a dollar in sales.

Institutions own 60% of shares.

Teck next publishes earnings on Feb. 11. The stock goes ex-dividend on Dec. 11 for a semiannual payout of 45 cents per share.

Liquidity and Volatility

TCK on average trades 3.2 million shares a day and supports a moderate selection of option strike prices spaced a dollar apart., with open interest running to three figures.

The front-month at-the-money bid/ask spread on puts is 3.2%, compared to 1.4% on the most traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 50%, compared to 12% for the S&P 500 index. TCK's volatility is in the 78th percentile of its rise to its October high of 58%. It peaked in mid-October, declined to the end of the month and since then has recovered somewhat.

That level of volatility implies that the most profitable trades will be structured as short option spreads, sold for a credit and expiring in the front month. This is my preferred sort of trade, since it either makes its profit or fails in a short amount of time, allowing me to move my funds on to the next trade.

Options are pricing in confidence that 68.2% of trades will fall between $12.58 and $16.88 over the next month, for a potential gain or loss of 14.6%, and that 95% will fall between $10.44 and $19.02.

Options are trading slowly today, with calls running at 93% of their five-day average volume and puts at 62% of average.

Decision for My Account

With short options spreads, brevity is everything. I judge my best opportunity to be a play on the options expiring about two weeks away.

I intend to structure the position as bear call spread, short the $15 calls and long the $16 calls, sold for a credit and expiring Dec. 19.

The best I can do with the December options grid  has a 62.2% probability of expiring out of the  money for maximum profit. It protects to the upside up to $15.19 with a 4.3:1 risk/reward ratio, at the outer edge of acceptability.

It stands on the lower runs of high probability trades, but given the brief time left before expiration, it will do the job.

Given the role played by time decay in this trade, I've open the position immediately rather than waiting for the end of the trading day.

-- Tim Bovee, Portland, Oregon, Dec. 5, 2014


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.

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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