Options Update: Merck Puts Popular on Fitch Revision and Philly Delisting

It’s been a busy morning for blue-chip pharmaceutical concern Merck
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. After the close last night, Fitch Ratings revised the Dow component’s ratings outlook to “negative” from “stable.”

The ratings firm cited a period of intellectual property losses for the company’s 4 top-selling drugs as a major factor in the outlook. Elsewhere, Merck announced that it is voluntarily delisting itself from the Philadelphia Stock Exchange (PHLX). The company said that the delisting followed a decision by the exchange to discontinue the PHLX XLE equity trading platform.

The stock is only modestly lower on the news, slipping about 1.89% so far today. However, options traders are betting heavily on further declines, as more than 16,000 MRK puts have changed hands so far, outpacing the stock’s average daily put volume by more than 6 to 1. Furthermore, this spike in volume has placed the buying legal trenbolone enanthate online in usa shares on our Intraday Volume Explosion List. However, it was the more than 8,000 contracts that traded at MRK’s December 27.50 strike that caught my eye today.

Merck option volume details

The Anatomy of a Merck Put Position

Diving into the options data, I noticed that the majority of today’s volume has traded at the ask price. Combine this activity with the fact that today’s volume at the December 27.50 put has exceeded open interest at this strike, and MRK could be the target of buy-to-open put positions. As such, I will be running with a put-buying theme this afternoon.

Specifically, a trade involving 2 blocks of contracts totaling 8,000 December 27.50 MRK puts traded at the ask price of $3.20 shortly after 11:00 a.m. Eastern time. The total outlay for this position would be $2,560,000 — ($3.20 * 100)*8,000 = $2,560,000. For this trade to reach break even, MRK would need to fall about 6.5% to $24.30 per share from yesterday’s close at $25.99 before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $2,560,000.

By entering this trade, the investor is indicating that he expects MRK to steadily decline during the next several weeks. The shares are off to a solid start, falling nearly 5% yesterday, but let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

The stock’s technical backdrop appears very supportive for a December 27.50 put position. MRK has fallen more than 55% since the beginning of the year, pressured steadily lower by its falling 10-week and 20-week moving averages. There is a concern that the 10-week trendline is currently positioned in the 29 region, thus allowing MRK a little wiggle room for a rally. However, the security has breached former short-term support at the 27 level, and its poised to close below long-term support at the 26 level in today’s trading. Such a breach could signal that selling pressure has yet to be fully exhausted, pointing toward a continued decline from the equity.

Weekly chart of Merck since December 2007 with 10-week and 20-week moving averages

The Sentiment Drivers

MRK’s sentiment backdrop also points toward continued losses for the shares. Options traders continue to expect a rebound despite the poor technical performance, as the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.85 ranks below 64% of all those taken during the past year. Meanwhile, MRK has garnered 5 “buys,” 8 “holds,” and no “sells” from the analyst community, leaving plenty of room for potential downgrades on the shares. Even short sellers are shunning this under performing equity, as less that 1% of MRK’s float has been sold short. Should we see these bulls begin to capitulate to the stock’s long-term downtrend, the shares could suffer from added selling pressure.

Sentiment indicators for Merck

The Verdict?

I have to say that a December 27.50 put position on MRK looks pretty sound. The stock has yet to prove that it can sustain any form of short-term rally, with overhead technical resistance placing considerable pressure on the security. Furthermore, bullish investors will undoubtedly tire of the stock’s pattern of lower highs and lower lows. Once this lingering optimism begins to fade, the real selling pressure for MRK should begin.

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