Options Update: Bullish Investors Pile into EMC Corp. Call Options

Shares of EMC Corp. are up more than 5% in midday trading, as the shares ride the wave of buying pressure sweeping across Wall Street.

Digging through the headlines, I found no significant reports or releases pertaining to the company, and it appears that general strength within the oversold technology sector is providing the majority of today’s lift for the shares. The rally has taken EMC to within striking distance of former support at the 10 level, and options traders seem to be betting that the shares are poised to not only reclaim this region, but accelerate to the upside.

Specifically, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.38 indicates that calls nearly triple puts among near-term options. Furthermore, this ratio ranks below 96% of all those taken during the past year. Looking at our Intraday Volume Explosion List, it would seem that speculative options traders are pushing this bullish sentiment even further, as more than 31,000 calls have changed hands on the security so far. This wealth of activity has easily outpaced EMC’s average daily call volume by more than 3 to 1.

The most active contract is the December 11 call, which has seen more than 13,000 contracts trade on open interest of 33,973. With volume falling well short of open interest, it is initially unclear whether today’s activity represents the initiation of fresh positions. That said, the fact that quite a few December 11 calls changed hands at the ask price suggests that the contracts might have been bought to open.

EMC Corp. option volume details

The Anatomy of an EMC Corp. Call Position

Digging into this call activity, I noticed that 1 block of 1,999 contracts changed hands at 10:42 a.m. Eastern time at the ask price of $0.31. The total outlay for this position would be $61,969 — ($0.31 * 100)*1,999 = $61,969. For this trade to reach break even, EMC would need to rally about 21% to $11.31 per share from yesterday’s close at $9.30 before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $61,969.

By entering this trade, the investor is indicating that he expects EMC to rally sharply during the next several weeks. The shares are off to a solid start, rising more than 5% so far today, but let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

From a technical perspective, the stock has dropped more than 49% on a year-to-date basis, edging out the S&P 500 Index’s (SPX) loss of more than 45% for the same time frame. Furthermore, the shares have even underperformed their sector peers in the Select Sector Technology SPDR (XLK) on a relative strength basis since October 2007. During this time frame, EMC has battled overhead resistance at its 10-week and 20-week moving averages. In recent weeks, the shares have bounced around between short-term support near the 9 level and overhead resistance at their declining 10-week moving average. When push finally comes to shove, this oppressive trendline could prove problematic for a December 11 call position.

Daily chart of EMC Corp. since May 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

The biggest hurdle for nearly any call position on EMC is the excessive degree of bullish investor sentiment. As I mentioned above, options traders are placing sizable bets that the shares will extend today’s technical strength. Drilling down on the open interest configuration, peak call open interest resides at the 11 strike in the November series, totaling nearly 34,000 contracts. Meanwhile, peak put open interest for the November series rests at the 9 strike, with a mere 13,000 contracts. This skew toward out-of-the-money call options indicates that investors are not expecting EMC to reverse course anytime soon.

Outside of the heavy call activity in the options pits, Wall Street analysts are firmly entrenched in their optimistic outlook for the company. According to Zacks.com, 16 of the 21 analysts following EMC rate it a “buy” or better. This configuration provides ample room for potential downgrades, which should be particularly disconcerting for EMC bulls with global IT spending rapidly declining.

Sentiment indicators for EMC Corp.

The Verdict?

The facts are these: EMC is locked in a long-term downtrend, with several technical hurdles looming overhead – including round-number resistance at the 10 level and the stock’s declining 10-week moving average. Furthermore, there is an excessive degree of investor optimism being levied against the shares, which could pose a problem for EMC if the shares fail to impress these bulls. The potential for another round of selling pressure on the shares would be enough to dissuade me from jumping on an EMC call at the moment. If the stock can prove that today’s rally has some staying power, i.e. a rally above 12.50 (home to its 20-week trendline), I might take a closer look at a long position.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.