A Bearish Market Shift?

08/04/2006 12:00 am EST

Focus:

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Options expert Bernie Schaeffer notes "recently, a number of "momentum" names, saddled with heavy short interest, have become a virtual minefield for the bulls. Here’s a look at his latest commentary…

"While we generally view solid short-interest ratios as a positive contrarian sign, the indicator can only be interpreted as such if the underlying technical trend continues to run counter to the sentiment. Short interest on a stock that is breaking down isn't as attractive, contrarily speaking, as continued short additions on a stock that retains the (up)trend as its friend.

"Heavily shorted momentum plays Wynn Resorts (WYNN NASDAQ) and Zoltek Companies (ZOLT NASDAQ) boast short-interest ratios (SIR) of 9.45 and 5.76 days to cover, respectively. And more than 17% of WYNN's float has been sold short, and 28% of ZOLT's available float is devoted to the short side.

"The technical health of the equities themselves, on the other hand, has deteriorated markedly in recent months (although they remain above long-term support zones). WYNN rallied more than 90% between late September and early April, but after several failed attempts to clear the 80 mark, the stock succumbed to downward pressure in mid-May and has spiraled 21% lower since. This decline has brought the stock beneath its ten-week and 20-week moving averages, which have themselves completed a bearish crossover.

"ZOLT more than quadrupled in price between early December and mid-May and has shed 40% of its value in less than three months' time. ZOLT shares are also now perched below their ten-week and 20-week moving averages, which are currently in the process of forging a bearish cross.

"It would not be a huge stretch to conclude that we are moving into a more bearish market environment. The short sellers are starting to win the battles among momentum issues, making these names a very dangerous game. Meanwhile, overloved large-caps continue to gasp for air, only to break down even further. While this is not a pretty combination, I'm not yet willing to sound the bearish alarm just yet. The S&P 500 Index (SPX - 1,276.66) remains above long-term moving average support, and huge put open interest continues to guard against any destructive downside.

"But such market behavior suggests that one, at the very least, should have a list of stocks to avoid at all costs from the long side if we find ourselves in a more bearish environment. And for the more aggressive traders who employ shorting as part of your overall strategy, now might be an ideal time to research some shorting candidates."

Related Articles on