"Valeant" Effort for Contrarians

06/05/2014 7:00 am EST

Focus: STOCKS

Our latest options idea is based on a stock that has been steadily making its way up the charts. Despite its technical prowess, sentiment has been growing increasingly bearish, which we consider as bullish from a contrarian standpoint, explains Karee Venema in Schaeffer's Investment Research.

Valeant Pharmaceuticals International (VRX) has gotten a lift from its 160-day moving average. In fact, since climbing north of this trend line in August 2012—when VRX was trading around $50—the shares have surged roughly 157% to their current perch at $128.73.

In April, the equity pulled back to this historical trend line after tagging a record peak of $153.10 in late February, and bounced. The stock is once again consolidating near here and—according to data compiled by Schaeffer's Senior Quantitative Analyst, Rocky White—this could spell additional gains for VRX in the near term.

Specifically, in the five other times this signal has occurred, VRX has gone on to average a 21-day gain of 6.7%, and is positive three-quarters of the time during this same time frame.

The stock's Schaeffer's put/call open interest ratio ranks higher than 80% of similar readings taken in the past year, meaning short-term speculators are more put-heavy than usual.

In the June and July series, heavy accumulations of put open interest currently reside at the underfoot 125 strike. Going forward, this level could translate into an additional layer of support, as the hedges related to these bets unwind ahead of expiration.

Elsewhere, short sellers have been climbing on board at a rapid-fire rate—which is a fairly common arbitrage tactic toward a company seeking to acquire another firm, as is the case with VRX and its bid for Allergan (AGN).

In particular, short interest surged 266.3% over the past two reporting periods, and, with 14.3 million shares currently sold short, it would take nearly a week to cover these bearish bets at VRX's average daily pace of trading.

Should the stock continue to make headway on the charts, a capitulation by short sellers could help fuel the security's fire.

Those looking to bet on an extended uptrend for Valeant may consider purchasing the stock's August 115 call options. This in-the-money strike was last asked at $17.80.

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