Today's Consolidation Is a Win for Bulls, Assuming the Lows in Place Hold Into the Close

Schaeffer's Investment Research
  DEC 19, 2012 4:00 PM

Plus, Smith & Wesson is extremely oversold and option sentiment has reached an extreme.


Market Check

After yesterday’s big move higher, markets are currently flat for the most part today.  Today’s open looked like we could potentially have another move higher, but that small gap up was met with responsive selling, and we remain near the bottom of the daily range as of 2:12 p.m. EST. Currently, the Russell 2000 (INDEXRUSSELL:RUT) is leading, up about 0.5%, while the S&P 500 (INDEXSP:.INX) is a relative laggard, down 0.3% on the day.  After yesterday’s bond swoon, the fixed-income assets have found a bid today and are up about 0.5%.  With the exception of crude oil, major weakness continues across most commodity markets.
Chart of the Day

After the recent school shootings in Connecticut, guns and gun makers have been at the forefront of daily news, controversy, and solicited potential legislation. As you can probably imagine, the widespread cries for new gun control laws have had a serious impact on stocks in this sector. While this headline risk does exist, it’s my belief that the fear is a little overblown at present time.

After rallying over 150% since January 1, shares of Smith & Wesson Holding Corporation (NASDAQ:SWHC) have imploded over the past two weeks, down about 20%. However, the equity remains a major outperformer for the year, and it looks as if this could be a decent entry for a long position. Looking at a longer-term chart of the equity, you’ll notice that the 8 level has been significant numerous times over the past few years. Additionally, peak put open interest in the January options series resides at the 8-strike. Those short these options could support the stock at that strike. Lastly, SWHC is extremely oversold and option sentiment has reached an extreme. The current front three months’ open interest has the highest ratio of puts versus calls as seen at any time over the past 52 weeks. These newly-initiated bearish plays could act as a headwind toward SWHC should the option holders capitulate on their positions. This is not a high probability setup, but the risk/reward tradeoff is extremely favorable. A close below the 8 level would be a sign to exit the position, while a quick rally back to the 11 level seems very possible.

Click to enlarge

What I'm Expecting

I expect to see continued choppy markets for the rest of the day, and potentially tomorrow as well.  We remain at the top of the recent range, and 1440 on the S&P 500 looks like it will continue to act as support. Today’s consolidation is a win for the bulls, assuming the lows in place hold into the close. Continue to buy dips on pullbacks, and only take your best short setups as they arise.

This article by Bryan Sapp was originally published on Schaeffer's Investment Research.

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