Our Uncle Ben once told us that "with great power comes great responsibility," and we try to consider this nugget of wisdom when we approach our column each week. Even though Rocky has the ability to construct a filter for just about any odd data point you can imagine -- say, for example, stocks starting with the letter "D" that have averaged positive returns on each of the past five odd-numbered Wednesdays -- we make a concerted effort to try and determine the most useful information for you, our faithful readers. (Hi, Moms.)
So, in constructing a supremely useful stock filter for short-term bearish opportunities, we stumbled across the shares of Energy Conversion Devices, Inc. (ENER). Based on our analysis, the stock could be poised for more downside during the coming weeks. Don't believe us? Well, allow us to make our bearish case.
Starting with the charts...
It's usually not a good idea to fight the laws of physics, so we decided to filter for stocks that are already technical underperformers. ENER certainly fits the bill, with the shares having shed more than 50% of their value year-to-date. By contrast, the broader S&P 500 Index (SPX) is sitting on just a modest deficit for 2010.
Of course, nobody wants to short a stock right when it's hit bottom. Fortunately for our purposes, ENER has enjoyed a minor rebound since tagging an annual low of $3.76 on July 7. The stock's path higher is hardly clear, though -- looming overhead are ENER's 20-week and 32-week moving averages, which have suppressed the shares consistently since September 2008.
A continued climb by ENER would carry the shares directly into a confrontation with this double-barreled resistance, creating an opportune entry point for potential bears.
Of course, the equity's price action isn't the only reason why we're not so keen on ENER -- the stock's sentiment backdrop also raises some red flags.
Calls are still the options of choice
Despite ENER's relatively dismal price action, options players continue to favor calls over puts. During the past couple of months, traders on the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) have bought to open 11,606 calls on ENER, compared to just 979 puts -- revealing an overwhelming preference for bullish bets over bearish.
In fact, ENER's 10-day ISE/CBOE call/put volume ratio of 16.97 ranks in the 81st annual percentile, indicating that speculators are purchasing calls over puts at a faster pace than usual lately. As Rocky puts it, "The low stock price surely has something to do with this, but still."
In other words, it's not unusual to see a natural skew toward calls over puts on low-priced stocks, since there will typically be fewer viable put strikes available with which to bet on continued downside. Nevertheless, that preponderance of bullish bets can still cause mayhem with the shares.
For example, ENER's August 5 strike is home to peak call open interest of 2,613 contracts, all of which are narrowly out of the money. As expiration draws closer, the ill effects of options-related resistance could create additional technical trouble for the stock.
Plus, ENER has a hefty accumulation of short interest, with bearish bets representing a lofty 25% of the equity's float. If the shares were moving higher, we would consider this to be a bullish indicator, from a contrarian perspective, since the shorts would have plenty of motivation to rush to cover. However, high short interest on a downtrending stock can actually create more downside volatility, making this another solid point in our case against ENER.
In fact, ENER pretty much completely failed to benefit from a recent 22% drop in short interest, with the shares still pinned beneath multiple layers of familiar resistance. The equity's inability to capitalize on this burst of short-covering support hints at deep-seated technical weakness.
So, in essence, we would advise that you not be fooled by the stock's recent gains. Instead, you might want to consider any challenge of trendline resistance by ENER to be a potential entry point for a bearish trade.
And, as always, please contact us with any questions, comments, or suggestions for future columns.
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