The market reaped the benefits of a “Dead Cat Bounce” early in the week as some buyers moved into the vacuum created in the market by recent. While the S&P 500 and other major indices were up dramatically, they turned downward on the Fed announcement—a strong reminder for traders that it’s not the time to buy, but instead time to buy strength.
You don’t need to look much further than the homebuilding sector to find some strength worthy of buying. Since Ben Bernanke and the Fed started writing their $400 billion (with a “B”) QE3 checks every month to buy mortgage-backed securities (MBS) the S&P 500 is down about 5.5%. Comparatively, the SPDR S&P Homebuilders ETF (NYSE:XHB) is unchanged. Looking closer at the stocks within the Homebuilders ETF finds some nice strength though, the kind that you trade in a market like this, namely a stock like Leggett & Platt (NYSE:LEG).
Since QE3 started, shares of LEG are up 7%. A strong earnings report in late October helped as the company bested analyst expectations for earnings by generating 7 cents per share for the last quarter, coming in at 45 cents against expectations for EPS of 38 cents. The improving picture for the housing market, which was confirmed on Monday with a better-than-expected sentiment number for the housing market and improving monthly home sales figures, bolsters the outlook for housing-related stocks like LEG.
The stock is set to continue outperforming the market based on a number of factors, including the following three bullish trade drivers:
- The stock remains in a firm uptrend, despite the market’s weakness, supported by its 20-day moving average along with potential support from its 50-day trendline (see chart below). This suggests that the stock would get “support” that the rest of the market has already surrendered.
- Investor sentiment towards LEG shares is decidedly negative, suggesting that the stock is climbing a “Wall of Worry.” For example, short sellers have been forced to cover positions lately as the stock has continued its climb. The current short interest data suggests that there is still an increased chance of this activity continuing. Option volatility is also at its highest levels over the last year, backing-up the “Wall of Worry” claim.
- LEG shares are one of less than 20 S&P 500 companies that have been able to post new 12-month highs recently. Typically, stocks posting new highs like this will attract additional buying interest as investors seek strength in both strong and weak markets.
So where does it go from here?
Over the short-term, expect to see the shares move to $28 with little resistance. At that price, traders may sell into the strength if the market remains weak. A stronger market will help LEG shares break above $28 and likely land at $30 before the year’s end.
Short-Term Trade: Short-term traders can buy the stock at current levels and expect a 4% return if the shares hit the initial target of $28 and 11% on the intermediate-term target of $30. A sensible stop-loss price of $25.25 makes sense as this represents a break of likely support at the stock’s 50-day trendline.
Aggressive Trade: More aggressive traders may choose to use options to leverage a move. The LEG January 25 calls are selling for $2.10 per contract and appear attractive for those educated in trading options. This option could reach a price of $5.00 or better (based on intrinsic value alone) if the stock reaches the $30 price target, netting an attractive return over the short-term.
We can’t reveal the source of this trade, but who is Trader X?
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