Contrary to your suspicion after reading the title, I was not smoking any cannabis products when I wrote today’s note. But let’s get the negatives out of the way before sharing the opportunity in IBM (NYSE:IBM) stock.
I’ve been a critic of IBM’s management because they have failed at adapting to the new world order. They have yet to complete the transition into the new tech world, which centers around subscription services. They keep talking the talk, but every earnings report shows disappointing progress.
Meanwhile, companies like Microsoft (NASDAQ:MSFT) got the job done, and that’s why Wall Street rewarded them with record prices. IBM stock is almost 40% below its all-time high so clearly they have more work to do.
The Upside in IBM Stock
Having said that, today’s write-up is to share an 18% upside opportunity in IBM. This is a technical setup and it’s completely independent of my opinion of IBM’s management. I believe that they need a new CEO, but for some reason Wall Street still hasn’t pushed Ginni Rometty out from the job. For today’s purpose, this does not impact this bullish opportunity.
The entire stock market corrected hard last October and it didn’t end until late December. During that time, IBM fell 30%. But the story has a happy ending, because on Christmas the market bounced. IBM stock rallied 35% to recover almost all of its losses. But it stalled at a significant volume level which is a point-of-control around $145 per share. So it failed to recover the $153 to fill the whole correction range.
What killed the rally were the most recent earnings. The negative headline reaction caused IBM stock price to fall 13% since mid April. The good news is that this almost fills the gap that the prior earnings spike left open.
The IBM recent levels are neat. The rallies and corrections happen at levels that make technical sense, so they weren’t surprises. And this gives today’s opportunity trade clear target and stop-loss levels.
For the last few weeks, IBM has been building an inverse head-and-shoulders pattern where the neckline is just above current price. If the bulls can break out from $137, they will invite momentum buyers to carry it up to $145 per share.
But this is where it gets interesting, because that would put IBM at the doorstep of an even bigger bullish pattern. If the price can rise above $146, it would kick-start a cup-and-handle-ish pattern to target $160 per share. There will be resistance along the way had $153.
Simpy put, I’m suggesting that there is a small bullish pattern developing here that could also launch a secondary and bigger pattern above. Together they would catapult IBM stock to $160 per share or higher. In total, the opportunity from today could exceed 18% upside.
This will require the help of the entire market. Today’s Fed binary event and next week’s China trade deal rhetoric are two big extrinsic variables that could gravely affect the odds of the opportunity at hand.
Levels to Watch in IBM
Since this is a trade not an investment, stop losses are important. There are lines below to note, but these depend on personal risk tolerances. For the lower-time-frame stops, $134 per share is important. This applies to traders who want a tight stop and do not want to turn this trade into an investment.
For traders with a bit more patience, IBM has support through $132 per share. So if the price action can stay above it then today’s setup is still alive. Conversely, losing $126.75 would trigger a bearish pattern that would target $118 per share. While this is not my forecast, it is a scenario that exists if things get ugly.
There is a twist in this story which is good news for those who are bullish IBM for the long term.
On the weekly chart time frame, IBM has been setting higher lows and lower highs and it is coming into a point. More interesting is that this also coincides with important levels from February 2016. When this happens, usually there is a big move that follows but the direction is yet unknown. For as long as IBM continues to set higher lows then odds are that the bulls will prevail.
Click to Enlarge And if this is the case then they will break out of the descending trend line of lower highs. So here we have two different bullish setups on different time frames. They converge here so they could combine to make the 18% rally in IBM almost certain. We recently had that happen to Snap (NYSE:SNAP) where two scenarios on two different time frames one long and one short both converged and let to a great rally there.
At these levels and since IBM has a forward price-to-earnings ratio of 10 it has little froth in it. Owning it here is not likely to be a financial tragedy. So the upside opportunity is far greater than the downside risk especially if I use tight stops.
Or investors can use the options markets, where the out-of-pocket risks is much smaller and the reward is definitely bigger.
In options I can buy Aug $160 calls for 60 cents per contract. This is a small price to pay for a time limit bet. But the disadvantage in using options is that time is my enemy. If I own IBM shares, time doesn’t diminish their value like in options.
That’s why I personally prefer selling puts to express my bullish thesis. I can sell the October $100 put and collect $1 to open the trade. This way I don’t even need a rally to profit. As long as IBM shares are above $100 in mid October then I win. If IBM collapses, I accumulate losses below $99 per share but that is much better than owning shares and riding them all the way down from here.
Options are tricky, so I would never sell naked puts unless I am willing and able to buy the shares at that price. Otherwise, I would use bull put spreads instead.
Regardless of the method, today’s upside opportunity in IBM’s is there for the taking.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room free here.
