Why the risk/reward didn't align for a MRK call option
Our traders are stalking a lot of different stocks throughout the week, but not every potential trade idea develops into a formal recommendation to our subscribers. Whether it's the break of a key technical level for the shares, an unexpected news announcement, or an unfavorable options pricing environment, this regular feature will shed some light on the factors we view as "deal breakers" to otherwise intriguing trade setups. Today, Schaeffer's Senior Equity Analyst Joe Bell, CMT, chimed in on one stock he was recently toying with -- but ultimately rejected -- for a long call position: blue-chip pharmaceutical concern
Merck & Co., Inc. (NYSE:MRK).
What He Liked About MRK Calls
Specifically, MRK caught Bell's eye earlier this month because:
- MRK stock had pulled back to an upward-sloping trendline connecting the higher lows since its February 2016 low.
- The stock had bounced from this level and the MACD histogram was starting to turn higher.
- MRK was in a long-term uptrend, up about 200% since the 2009 bottom.
- The stock was pulling back to the $64 area, which was near the site of most of the post-earnings trading on Feb. 2. "This would be a logical place for buyers to come back to the table, especially given its strong report," Bell said.
Why He Backed Out of a MRK Trade
However, Bell ultimately rejected MRK calls due to the following:
- "Sentiment just wasn’t very bearish" -- what we like to see when hunting contrarian gems. "The majority of analysts recommended buying the shares, option speculators were mainly buying bullish calls, and there aren't too many shorts targeting MRK. I would have liked to see more pessimism," Bell said.
- The stock's 200-day moving average had been supportive in the past and was still a few points below MRK stock at the time the trade was considered.
- "Although the MACD line was trending higher, I decided to wait until it at least turned positive."
