When it comes to investing, a new price trend is something we all can enjoy. But when you can effectively hedge that bet with a pairs trade in CVS (NYSE:CVS) and Merck (NYSE:MRK), that’s a prescription for profits. Let me explain.
It nearly goes without saying interest rate policy and the U.S. China trade war have been on most investors’ minds of late. Some days Wall Street is bullish, while on others, it’s seemingly the end of the world as we know it. But for MRK stock and CVS shareholders, real catalysts off and on the price charts are happening right now.
On Thursday, the Donald Trump administration announced it is walking away from a plan to eliminate rebates large pharmaceutical companies pay to pharmacy benefits managers, which negotiate drug prices on behalf of buyers such as insurance companies. Bottom line, for a drug manufacturer like Merck, this is potentially a huge headwind. Likewise, it could be a boon for CVS stock.
Under the scrapped rebate proposal, Merck would more or less have been able to retain its lucrative pricing model. Now though, and with the Trump administration still searching for a victory in promised lower healthcare costs to individuals, it’s likely drug companies are going to be casualties to that end. That’s bad news for MRK shareholders. And conversely, much of what’s been ailing CVS stock has been eradicated.
And on the price charts of CVS and MRK, reaction to the reports have confirmed the prescription for long-term profits by pairing up an improving CVS stock and a fatigued-looking MRK stock.
Buy CVS Stock
Shares of CVS stock have been correcting for the past four years, since hitting an all-time-high of $103.64 in July 2015. The days of CVS’ bearish cycle, however, don’t just look numbered — they appear to be all but over.
As the monthly chart shows, this week’s news-induced bid has confirmed a monthly candlestick pivot low in shares of CVS. More importantly, the low is supported by the 62% retracement level dating back to the financial crisis. Further, stochastics is bullishly backing up the idea of a meaningful bottom as the indicator signals a crossover in oversold territory.
CVS Stock Trade: Buy CVS stock today, look for upside towards $75-$80 in the coming months and size your position accordingly based on pattern risk of around 11%.
Short MRK Stock
Shares of MRK stock look prone to a larger cycle of profit-taking following what I’ll call a period of bullish influenza after breaking out last July from a corrective base-on-base pattern. The news this week has had the effect of shaping a confirmed bearish engulfing reversal candlestick.
The monthly chart in Merck also shows a bearishly supportive setup, as the indicator has been bearishly diverging from the price as new highs were hit. Net, net the technical evidence points to profit-taking and possibly an even larger bearish cycle for MRK stock.
MRK Stock Trade: Short MRK stock today. Similar to CVS, a slightly larger stop-loss of 11% looks appropriate for containing dollar risk. Exit the position if the topping pattern turns lethal for bears and shares manage to make new highs.
Investment accounts under Christopher Tyler’s management do not own positions in any securities mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional options-based strategies, related musings or to ask a question, you can find and follow Chris on Twitter @Options_CAT and StockTwits.