Cummins Bears Could Get Run Over

01/04/2011 3:43 pm EST

Focus: STOCKS

Andrea Kramer

Associate Editor, Schaeffer's Investment Research, Inc.

Shares of the truck engine manufacturer led the S&P 500 for most of last year, yet have seen plenty of put buying of late, writes Andrea Kramer of Schaeffer’s Investment Research.

Cummins (NYSE: CMI) finished 2010 as the Standard and Poor’s 500 index's top performer, boasting an annual gain of 140%. In fact, the engine maker tapped a fresh all-time high of $111.87 during the year’s final session—and lured a slew of bullish option bettors as a result.

[Netflix (Nasdaq: NFLX) and F5 Networks (Nasdaq: FFIV) posted even headier 2010 gains, but didn’t join the S&P 500 until Dec. 10—Editor.]

CMI saw some 5,000 calls cross the tape Friday—more than doubling its predicted daily call volume, and about five times the number of CMI puts exchanged. The majority of the volume has centered on the in-the-money January 2011 105-strike call, which has seen about 3,900 contracts change hands on open interest of fewer than 1,500, pointing to fresh positions. Plus, 72% of the calls have traded at the ask price, confirming our theory of newly purchased bullish bets.

However, despite CMI's status as the ultimate broad-market standout, Friday’s affinity for long calls ran counter to the recent trend. On the International Securities Exchange (ISE), the stock had racked up a 10-day put/call volume ratio of 3.46, implying that traders have bought to open more than three CMI puts for every call during the past two weeks. What's more, this ratio ranks in the 94th annual percentile, indicating that speculators have initiated bearish bets over bullish at a quicker clip just 6% of the time during the past 52 weeks.

No Shortage of Doubters
Echoing that trend, the security's Schaeffer's put/call open interest ratio of 1.63 suggests that puts comfortably outnumber calls among near-term options. In fact, this ratio stands in the 89th annual percentile, hinting at elevated levels of pessimism among the near-term options crowd. Should the shares of CMI extend their long-term run into the black, an unwinding of skepticism in the options pits could serve as a contrarian catalyst even higher for the security.

[Cummins shares traded down to $109 Tuesday. The company made Jim Jubak’s list of stocks to own in 2011, because he believes its sales of truck engines will accelerate this year—Editor.]   

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