When resistance becomes support

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(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Jan. 11.)

This week I want consider some stocks that match one of the most basic technical developments out there: When an old resistance level is broken, shares pull back to test it as support.

Such moves seem to have a high probability of success, especially when the longer-term trend is higher. Once again, these are suggestions and not trade recommendations per se, so please do your own homework.

ED Consolidated Edison (ED): This New York utility has been in a steady uptrend since the market bottomed almost three years ago. The $58-$59 area was resistance between September and early December, and now it's trying to hold that level after a pullback. One thing I really like about this name is that the options favor getting long. One idea is simply to go in the money, buying the February 55 calls for $4.30. They have almost no time value, so you get the leveraging power of the options virtually for free. (See this guide for using in-the-money options.)

Another idea for people who are more advanced is to sell the 50 puts and buy the 65 calls in either May or August. Given the fact that ED is closer to $65, this trade in theory should cost you money. But there is so much more demand for the puts that you can get paid entering this position, and end up with "free" upside exposure. I also like this approach because ED has multiple levels of support that would have to break for this trade to lose money.

VZ chart Verizon Communications (VZ): The telecom giant has been ripping on enthusiasm about the availability of Apple iPhones for wireless customers. It pulled back hard on worries that giving the gadget away will hurt profit margins, but it's now back to previous resistance around $38.50. Similar to ED, option prices favor the bulls. You could buy the February 36 calls for only about $0.20 of time value, or you could do a synthetic to exploit the elevated cost of protection. For instance, the February 38 puts can be sold, and the February 40 calls can be purchased for a small credit, even though the stock is almost midpoint between the two strike prices.

Monotype Imaging (TYPE): This small-cap technology company provides a series of tools for managing fonts on devices like smart phones, e-book readers, televisions and automobile displays. They seem to be developing a niche in an area that's becoming increasingly important as developers manage applications and content across multiple platforms, and now languages. TYPE's old resistance was around $14, but it's now pulled back to that level. It might go a little lower, perhaps to $13.50, so it's worth letting it settle or entering in stages. Earnings are scheduled for Feb. 16 before the bell, so look for strength into the release. (It's beaten estimates the last four quarters running.)

Life Time Fitness (LTM): Another name that has consistently surpassed estimates. This company runs fitness centers, but goes beyond the traditional model of jamming a bunch of machines into a room with blaring music. Its business model seems to encourages customer loyalty by providing a higher level of service and training. It's also based mostly in Minnesota, which means it has long-term growth potential in other markets. Could it be the Starbucks of fitness centers? The $43-$44 area was resistance for over a year, but now it's broken that level and pulled back to it. The earnings history has also been extremely strong and short interest is more than 20 percent of the float. It also reports on Feb. 16, so could rally into the release.

(Charts courtesy of tradeMONSTER )



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.


This article appears in: Investing , Options

Referenced Stocks: ED , LTM , TYPE , VZ

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