Schaeffer's Trading Floor Blog

Weekly Contrarian: Merck Bulls Should Be On Guard

High expectations surrounding underperforming MRK could create near-term headwinds

by 2/5/2013 12:19 PM
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Barron's recently featured an article entitled, "Merck Can Make it Work ," in which the author listed a number of setbacks global health care concern Merck & Co., Inc. (NYSE:MRK - 41.34) has encountered of late, including last Friday's revelation that the company may postpone FDA approval of its osteoporosis drug odanacatib until next year. This announcement followed in the footsteps of pipeline delays in 2012, including new medications to treat cholesterol and cancer, which were shelved for a variety of fundamental reasons. Additionally, the Dow component downwardly revised its outlook for fiscal 2013, explaining that rising sales of generic prescriptions are cutting into the company's top line.

While the journalist contends that MRK faces a string of setbacks in the near term, the company has at least five new drugs up for approval in 2013, plus an appealing dividend payment, which could help to whet shareholders' appetite. As the writer optimistically concludes, "for investors willing to wait, the shares could be the right prescription."


MRK has been a laggard on the charts, with the stock making a series of lower highs and lower lows in recent months. What's more, the equity has underperformed the broader S&P 500 Index (SPX) by more than 14 percentage points over the past 60 sessions, and surrendered around 16% since hitting a three-year peak of $48.00 on Oct. 18. More recently, the security has found a technical foe in the form of its 20-week moving average, which has not allowed a weekly close above it since early December.

MRK's fundamental and technical woes have done little to dissuade optimistic options players, as evidenced by data from the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). During the course of the past 50 sessions, traders have bought to open 82,811 calls, compared to 25,345 puts. The resultant call/put volume ratio of 3.27 ranks higher than 71% of other such readings taken in the past year, suggesting bullish bets have been placed over bearish at a faster-than-usual clip in recent months.

This trend toward calls has translated into a bullishly skewed gamma-weighted Schaeffer's put/call open interest ratio (SOIR) of 0.78 for MRK. In other words, near-the-money call open interest outweighs put open interest among options expiring in the front three-months' series of options. This lofty accumulation of calls could create an options-related layer of resistance as these bets begin to unwind ahead of their respective expirations.

This rosy outlook has spread outside of the options pits as well, where short interest accounts for a low 0.7% of the stock's available float. It would take less than two days to cover these shorted shares, at the stock's average daily pace of trading, suggesting a lack of sideline cash available to fuel any potential rallies.

Lastly, no fewer than 11 out of 17 analysts believe the stock to be a "strong buy," and the consensus 12-month price target of $48.28 represents a 16.8% premium to the equity's current perch (and stands in territory not explored by MRK since January 2008). From a contrarian perspective, MRK could encounter a fresh wave of selling pressure in the near term, should any of these upbeat analysts follow suit with the number of brokerages that slapped the stock with bearish notes on Monday.

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