Schaeffer's Tool Box: Betting on an Akamai Technologies Breakout

              

This column is designed to introduce you to some of the valuable trading tools available on the SchaeffersResearch.com Web site. Today, we're going to use the Schaeffer's stock screener to look for bullish trading ideas by sifting through stocks with heavy pessimism and strong technical performance. For more on why we think counter-trend sentiment can help guide your trading, please click here.

Probably the best way to find a potential bullish trade using the Schaeffer's stock screener is via the "Stocks showing heavy all-around skepticism" filter option. By selecting this option, the filter will return only those securities with strong price action and an unusually high degree of investor pessimism, including high Schaeffer's put/call open interest ratios (SOIR), heavy short interest, and bearish analyst ratings. With the basics out of the way, there are a few more settings to tweak. Below are my personal favorites:

• Heavy all-around investor skepticism
• A minimum stock price of $10 per share
• Minimum put & call open interest of 10,000 contracts
• Minimum average daily stock volume of 100,000
• Trading above their 20-day moving average
• Stocks near an annual high
• Total analyst rankings greater than 10

Stock Selection Via Sentiment

Despite returning only two results, today's filter still provides plenty of opportunity. Both Caterpillar Inc. (CAT: sentiment, chart, options) and Akamai Technologies Inc. (AKAM: sentiment, chart, options) have outperformed the S&P 500 Index (SPX) by more than 16% on a relative-strength basis during the past 60 trading days. Both also have an incredible amount of investor pessimism levied against them. For a closer look at CAT, check out today's edition of The Casual Contrarian: Caterpillar Inc. Continues to Prove Bearish Investors Wrong .

With CAT covered, I'll be examining the bullish prospects for Akamai today. As I mentioned above, the equity has drawn considerable ire from the investing community. Specifically, the stock's SOIR of 1.22 arrives higher than 82% of all those taken during the past year. The SOIR compares put and call open interest for options with less than three months until expiration, and is a good measure of short-term expectations from speculative investors.

Elsewhere, a hefty 15% of the stock's float is sold short, providing potential fuel for a short-covering rally. What's more, 13 of the 16 analysts following AKAM rate the shares a "hold" or worse, leaving room for potential upgrades.

Without getting too bogged down in the details, the key takeaway from this sentiment backdrop is that investors are not looking for AKAM to extend its strong price action, creating the potential for an upset of sorts. If the shares continue to rally, then put open interest could unwind, short sellers could begin buying back their positions, and/or brokerage firms could upgrade the shares. Since we entered into this filter expecting to find a bullish trading idea, these drivers make for compelling arguments in favor of AKAM's upside potential.

Getting Technical

As usual, the filter results are pre-screened to be outperformers. However, not all uptrends are created equal, and it is always a good idea to examine your potential trading ideas a bit more closely from a technical perspective. Zeroing in on Akamai Technologies' (AKAM: sentiment, chart, options) price action reveals that the stock has added nearly 50% so far in 2009. The shares have recently benefited from a burst of strength after tagging a low near $17 per share in early September. Since that near-term low, AKAM has rallied about 36% along the support of its 10-day and 20-day moving averages. The equity has also drawn its 10-week and 20-week moving averages into a bullish cross, a technical formation that often precedes additional gains for the shares.

There are potential drawbacks for a bullish position on AKAM. As you can see from the chart above, the shares are once again challenging overhead resistance in the 23-24 area. This region recently capped the equity in May and June, and created a brief trading range in August 2008. Meanwhile, the 25 level is home to a 50% retracement of the stock's November 2008 low ($9.25 per share) and its May 2008 high ($40.90 per share). Above this, the 29 area marks a 61.8% Fibonacci retracement of the aforementioned high and low.

Trading Expectations

So, we've run a filter looking for a bullish trading idea, discovered that AKAM has plenty of potential sideline money, and examined the stock's technical backdrop. What's next? If you aren't satisfied with AKAM's prospects - maybe you are concerned that the shares won't break out above the 23 level - you can repeat the process again, starting with Caterpillar Inc. (CAT) as a potential trading idea.

But what if you want to move forward with a bullish AKAM trade? Well, if you are a stock trader, you would simply set your stop-loss and target at comfortable levels, and purchase the shares. Assuming you are comfortable with a potential loss of about 10%, a stop-loss on a close below the 20 level could be a good starting point, as it means that AKAM will have dropped below support at its 10-week moving average. Setting the target depends on whether you expect the shares to be stopped at the 25 level, or continue to the 29 level (as mentioned above).

Option Selection

For options traders, the same reasoning applies regarding your expectations and risk tolerance. With less time premium built into the price, a November option would be less expensive, but will offer less time for your expectations to play out. You would want to avoid this month unless you had reason to believe that AKAM will achieve your goals before the options expire on Nov. 20. Given the data above, a less aggressive approach would be to trade the December or January 2010 options. Choosing an option in either of these months will incur additional costs due to the added time premium, but it will give you more time for the trade to play out.

Let's say that with AKAM hovering just below $23 per share, you decide to enter the in-the-money December 22 call. The option is currently trading with an ask price of $1.85, meaning that one contract would run you about $185 sans brokerage fees. In order for this trade to reach breakeven (i.e., in order for you to make your money back), AKAM would need to rally to $23.85 per share at expiration. It is important to remember that there is the potential for technical resistance in the 23-24 region, which could limit returns on the position. If you don't believe that the shares will overcome this hurdle, then you would want to reconsider entering this trade and select a different option.

However, if you expect AKAM to break out above the 23 level and rally up to the 25 level, then this trade could prove quite lucrative. If the trade does play out as expected, and AKAM jumps to $25 per share at expiration, the December 22 call would be worth $3.00, netting you a gain of about 62% on the trade at expiration, compared to the stock trader's gain of about 8.6%.

Remember, your risk tolerance may be different from my own, and I encourage you to expand on the research I've done here to arrive at your own conclusions. And always remember to set your stop-losses and targets before entering a trade.