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Don't Get Hit by Union Pacific


Some trains go in reverse.

Editor's Note: This content was originally published on the Buzz & Banter (click here for a free trial). It's being reposted here for the benefit of the Minyanville community.

After some initial follow-through buying this morning, shares of Union Pacific (UNP) and CSX (CSX) have now turned lower on the day. Yesterday I established a short position in Union Pacific for the OptionSmith portfolio. While I was a little early pulling in the trigger -- I sold shares at $58.90 -- I think my thesis for a short-term trade is still valid, and today's early reversal has soothed my nerves and slowed the frequency at which I was kicking myself for making such a perversely contrarian trade.

The basic reasoning laid out in the Alert was that that big premium paid by Buffett (see Video: The Frisky Buffett) for Burlington Northern (BNI) doesn't mean other rails should immediately be awarded a higher multiple, as their near-term business prospects haven't changed. Nor does it mean they should be given a takeover premium, as it's highly unlikely that anyone else can or will swing such deal. Nor does it suggest that mergers or consolidation are on the way. In fact, it's more likely that Buffett will have to sell his 10 million shares or 2% stake in Union Pacific. Not huge, but it does translate into supply rather then demand.

That said, money managers that need exposure to transports now have one less "pure" rail name, so some money should spill into Union Pacific and others, such as Norfolk Southern (NSC) and CSX. I think that's why they were up yesterday and early today as opposed to new bullishness or remodeling of earnings projections and awarding higher valuation on these companies.

Buffett has a very long-term time horizon and Burlington Northern can certainly earn its way into justifying the premium as the economy -- and the economies of rail versus road -- take hold over the next few years. But in the short term, the group still faces the challenges of a slowdown of goods and materials being moved.

The short position in Union Pacific was established with an eye towards the 50-day moving average at $60.25, which I hoped would act as some resistance. This morning's pop through to $61.20 made it look like momentum would carry the stock significantly higher. Hopefully a close below the $60 level will a bearish pole. My target is for the stock to fill the gap $56.30 in coming weeks. But I don't want to get run over by this train so I'll be keeping a close watch with a close above $60.50 as stop loss.

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Position in UNP.

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