Exploring the Turnaround Potential for CIENA Corp and Brocade Communications Systems Inc

01/09/2009 11:12 am EST

Focus: STOCKS

Nick Perry

Equity Options Trader, Schaeffer's Investment Research

A couple of stocks that caught my eye today are CIENA Corp. (CIEN) and Brocade Communications Systems Inc (BRCD). Both companies showed up on the scan for stocks showing unusually heavy volume, and CIENA also appeared on the stocks advancing amid heavy short interest scan. What drew my interest is that both stocks are trying to bounce from downtrends.


Chart Courtesy of Thomson Financial

These weekly charts give us some quick perspective on what has happened. Shares of CIEN have dropped from highs near $50, while those of BRCD have dropped from a recent peak near $9. With that in mind, lets check out the shorter-term action.


Chart Courtesy of Thomson Financial

Here, we have daily charts that show the last 90 days, and next to those, intraday charts that show the action for the last five days. The daily charts show sideways basing action from both stocks, while the intraday charts show steady short-term buying. In other words, we have stocks that appear to be trying to turn around. I think the key areas to watch are the overhead resistance zones that define the top end of the current consolidations.

To see if either might make for an interesting contrarian play, we need to turn to the sentiment picture. The graphs below show analyst ratings and the put/call ratio.

On these two measures, both stocks are very similar. We see that most analysts have thrown in the towel and moved to the sidelines. As a contrarian, I like to see this. Both stocks have a fairly large following, so this offers the potential for upgrades down the road if the companies can stage successful turnarounds. However, both stocks are seeing optimism from the option pits. This would rank as a near-term concern as it suggests that hopes are already high for a rally. Or, put another way, it suggests that some have already jumped into the stocks, and those optimists now represent potential selling pressure.
Given its inclusion on this morning's short interest scan, you already know that shares of CIEN carry a moderate amount of short interest. This can be viewed as potential buying demand. Brocade, however, carries very little short interest. According to data collected by our Quantified Analysis group, less than 1% of the stock's float is sold short.

Overall, the sentiment picture is somewhat mixed here. The strongest contrarian reads come when the sentiment runs counter to the price action. In other words, the best situation would be pessimism on a strong stock. In the current market conditions, strong stocks have become somewhat of an endangered species, so we need to adapt.

Both CIEN and BRCD are showing short-term overbought conditions, and as noted above, neither stock has broken out of the current range. As such, I would be inclined to wait for a breakout and a retest of the top of the former range. I think both stocks have potential, but I am looking for more proof of a sustainable turnaround. A bonus in the breakout/retest scenario would be if we saw some signs of skepticism from the option pits. In the near-term, short covering could help CIEN break out of its range, so I will be keeping an eye on that.

By Nick Perry of Schaeffer’s Trading Floor Blog

Related Articles on STOCKS