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A Closer Look at ... Allergan, Merck, and Pfizer

Posted
1/28/2011 1:45:00 PM
By: Schaeffer's Investment Research
Referenced Stocks:AGN;MRK;PFE

The pharmaceutical sector hasn't done much recently to attract the attention of traders. The AMEX Pharmaceutical Index (DRG) recently dropped below a trading range that had confined the index for the last two months. However, despite the overall sector's lack of excitement, there are some interesting investing opportunities to be had within the group. You just need to dig a little deeper.

Allergan ( AGN )

Allergan Inc. ( AGN ) is a leading maker of eye care, skin care, and similar products, including Botox. The firm's eye care products treat glaucoma, conjunctivitis, and chronic dry eye. Skin care products include treatments for acne, wrinkles, and psoriasis. Allergan also sells implants used in breast augmentation.

Technically speaking, the shares of AGN have been in a stellar uptrend along the support of their rising 10-week and 20-week moving averages. Since the stock put in a low of $28.95 in November 2008, the security has skyrocketed more than 140% along the support of these intermediate-term trendlines.

 WEEKLY CHART OF AGN SINCE NOVEMBER 2008 WITH 10-WEEK AND 20-WEEK MOVING AVERAGES

Despite the stock's stellar technical performance, traders have bet heavily against the shares. The International Securities Exchange (ISE) has reported that 28 puts have been purchased to open for every one call purchased to open during the past 10 trading sessions. This ratio of puts to calls is higher than 99.5% of all those taken during the past 52 weeks, pointing to a growing skepticism as traders try to call a top to the stock's rally.

What's more, the Schaeffer's put/call open interest ratio (SOIR) for AGN comes in at 1.32, as put open interest outnumbers call open interest among options slated to expire in less than three months. This ratio of puts to calls is higher than all other readings taken during the past 52 weeks. In other words, short-term options players have not been more pessimistically aligned toward the shares at any other time during the past 12 months.

Overall, an unwinding of this pessimism toward the outperforming stock could create a wave of fresh buying pressure. Traders should consider the stock's April 67.50 call to take advantage of a rally in the shares.

Merck ( MRK )

Merck & Co. Inc. ( MRK ) is a good example of a bearish opportunity in the drug sector. The pharmaceutical giant produces top prescription drugs such as asthma medication Singulair, hypertension fighters Cozaar and Hyzaar, and cholesterol combatants Vytorin, Zetia, and Zocor. The company also makes vaccines for diseases like measles, mumps, hepatitis, and shingles. Its over-the-counter offerings include Claritin allergy pills and Dr. Scholl's foot care products.

From a technical perspective, the shares of MRK staged a nice rally along the support of their 10-week and 20-week moving averages from May 2009 through April 2010 before falling off. The stock has now dropped below key support at the 34 level and appears to be headed for another test of longer-term support in the 30-31 region.

 WEEKLY CHART OF MRK SINCE MARCH 2009 WITH 10-WEEK AND 20-WEEK MOVING AVERAGES

Options players have ignored the stock's technical breakdown and are betting on a rebound in the shares. The ISE has seen 2.6 calls purchased to open for every one put during the past 10 trading sessions. This ratio of calls to puts is higher than 76% of all those taken during the past 52 weeks.

What's more, the SOIR for MRK comes in at 0.83, which is lower than 89% of all those taken during the past 52 weeks. In other words, short-term options players have been more optimistically aligned toward the shares only 11% of the time during the past 12 months.

Analysts on Wall Street also love MRK. According to Zacks , the stock has earned 15 "strong buy" ratings, one "buy," six "holds," and not a single "sell" rating. Any downgrades from this amorous group could spell trouble for MRK.

To take advantage of a sell-off in the shares of MRK, traders should consider the stock's April 34 put.

Pfizer ( PFE )

Finally, some stocks deserve the optimism they have won. A good example is pharmaceutical guru Pfizer Inc. ( PFE ). The company's best-known products include cholesterol-lowering Lipitor, pain management drugs Celebrex and Lyrica, pneumonia vaccine Prevnar, high blood pressure therapy Norvasc, and erectile dysfunction treatment Viagra.

Technically speaking, the shares of PFE are up more than 5% since the beginning of 2011. The stock has bounced off support at the 14 level and rallied along the support of its 20-week moving average, creating a nice "V" formation following its pullback in the first half of 2010.

 WEEKLY CHART OF PFE SINCE JANUARY 2010 WITH 20-WEEK MOVING AVERAGE

The stock's rally atop technical support has won over investors. The ISE has reported 10 calls purchased to open for every one put during the past 10 trading sessions. This ratio of calls to puts is higher than 92% of all the readings taken during the past 52 weeks.

In addition, the SOIR for PFE comes in at 0.45, as call open interest more than doubles put open interest among options slated to expire during the next three months. This ratio is lower than three-quarters of the readings taken during the past year. In other words, short-term options speculators have been more optimistically aligned toward the shares only 25% of the time during the past 52 weeks.

Analysts are also joining the love fest. According to Zacks , the stock has earned 16 "buy" ratings and five "holds."

PFE may encounter some resistance at the 20.50 region -- an area that capped the shares in the past. However, a March 18 call would allow a trader to collect a profit on a continued rally.

The winter 2011 issue of SENTIMENT magazine is now available here.