Our contrarian stock screening methodology has produced solid results in recent years
I am assuming most readers are familiar with our contrarian trading philosophy. In short, as contrarians, we look for stocks that have had bullish price action, but for which investors continue to have doubts and negative feelings. The idea is that the large number of doubters represents a lot of sideline money. As the stock moves higher and higher, at some point those doubters capitulate -- and if they all pile in at once, it creates a fast and furious stock rally, which is especially profitable for options traders like us. Another possibility, if the capitulation does not occur all at once, is it can play out over a longer period. A long-term steady rally can also be very profitable.
Meanwhile, for bearish bets, we look for the opposite setup. Specifically, we're seeking negative price action for a hyped-up stock.
As we get through the first quarter in 2017, I'm looking at what stocks would fit these criteria. It may give us a pretty good list of stocks to trade going forward.
Bullish Contrarian Setups: To find a list of bullish setups I first looked for stocks that have outperformed the S&P 500 Index (SPX) so far in 2017. With the index up over 5% year-to-date, any stock that beats this I would say has positive price action. To layer in sentiment, I looked at multiple data points to confirm investors had become more bearish on the stock. Specifically, I included stocks where option players, short sellers, and analysts were all showing a bearish view on the stock. Specifically, here are the criteria for this screen:
- The year-to-date return is better than the SPX.
- There was an increase in short interest.
- The percentage of analyst "buy" ratings declined on the year.
- The Schaeffer's put/call open interest ratio (SOIR) is greater than 1.00.
This is a pretty good starting point if you're looking for some bullish stock trades going forward:
Naturally, I reversed the criteria to find stocks that we may look at for bearish stock plays. or maybe simply stocks to avoid. Specifically, the criteria are:
- The year-to-date return is negative.
- There was a decrease in short interest.
- The percentage of analyst "buy" ratings increased.
- The SOIR is less than 1.00.
Last Two Years of Indicator: Even I was surprised how well this indicator has worked the last two years. Below, you can see how the bullish setups performed compared to the bearish setups and compared to all other stocks. I used the same criteria as above through the first quarter of the past two years, and then I found the stock returns for the rest of the year. These are stocks that had at least 5,000 contracts in open interest and eight analysts with coverage. Last year, the bullish setups averaged a return of 14.4%, with 79% of the stocks beating the S&P 500. The bearish stocks averaged a gain of 9.4%, with 64% beating the SPX.
In 2015, the contrast was even more pronounced. The bullish setups averaged a loss of almost 6%, with 56% of those returns beating the S&P. That doesn't sound great, but compare that to the bearish contrarian setups. Those stocks averaged a rest-of-year loss of 20.7%, with only 17% of them beating the index. Based on the numbers below, the stocks in the tables above are worth a look.
