It is often said that the best offense is a good defense. Given the recent saber rattling out of North Korea and the turmoil taking place in Iran, not to mention the ongoing wars in Iraq and Afghanistan, now might be a good time to take a closer look at the defense sector and the potential portfolio protection offered within. Since the market bottom in early March, the AMEX Defense Index (DFI) has rallied more than 45%. The index has also outperformed the S&P 500 Index (SPX) by more than 12% on a relative-strength basis during the past 60 trading sessions.
Technically speaking, DFI has enjoyed the support of its 10-day and 20-day moving averages since bottoming near 885 on March 6. The index is now poised to close its first month above its 10-month moving average since May 2008, and could maintain this peak, with potential technical support residing in the 1,250 area. This region provided resistance in February, April, and May, and could now provide a springboard for DFI on any pullbacks.
Despite this impressive outperformance, there are still signs of pessimism toward the defense sector from the analyst community on Wall Street. Of the 178 brokerage firm ratings on DFI's components, 44% remain rooted as either "hold" or "sell" ratings. This configuration leaves ample room for potential upgrades, which could boost the securities higher.
One potential opportunity within the defense sector is The Boeing Company (BA). The world's largest aerospace company is the No. 2 defense contractor in the U.S., behind Lockheed Martin, according to Hoover's. Boeing is also the No. 2 manufacturer of commercial jets, behind EADS N.V.'s Airbus unit.
Technically speaking, the best stock has gained 13% since the start of 2009. More impressive is the equity's 68% rally from its early-March low near $29 per share. Throughout this rebound, BA has been guided higher by support from its 10-day and 20-day moving averages. What's more, the shares are in the process of rebounding off the latter of these trendlines following a recent bout of selling pressure in the broader market.
Despite the security's stellar technical performance, investors are attempting to call a top to BA's rally. Among options players, we find that the stock's Schaeffer's put/call open interest ratio (SOIR) stands at 1.17, as puts outnumber calls among options with less than three months until expiration. This ratio also ranks above 88% of all those taken in the past year, pointing toward a sizable degree of negativity from the speculative options crowd.
Elsewhere, Wall Street analysts have sided with the growing negativity in the options pits. Currently, 15 of the 22 brokerage firms following BA rate the shares a "hold" or worse, according to Zacks. What's more, Thomson Reuters reports that the consensus 12-month price target for the best stock to buy rests at $47.26 per share - a discount to BA's Wednesday close at $48.55. Any upgrades or price-target increases could provide additional buying pressure for the equity.
On a final note, short sellers have abandoned BA in droves in recent months. The number of BA shares sold short has plunged from 12.7 million shares to a mere 3.3 million shares during the past six months. Should this trend continue, we could see BA benefit as a result of a continued short-covering rally.
To take advantage of BA's uptrend, investors should consider a 45-strike call option - the August call (premium is 10.7% of the share price) or November call (premium is 14% of the share price).
General Dynamics Corp. (GD)
Another potential opportunity in the defense sector is General Dynamics Corp. (GD). The company ranks behind Boeing in the defense business, arriving as the Pentagon's fourth largest contractor. That said, GD is no slouch from a technical standpoint. The shares have soared more than 65% since tagging a low of $35.28 per share on March 6. During this rally, GD benefited from support at its rising 10-day moving average. The shares were recently rejected by overhead resistance near the 61 level, but GD has since rebounded from support at its 32-day moving average. Furthermore, the shares are poised to close above formerly staunch resistance at their 10-month moving average for the first time since August 2008.
Like BA, the shares of GD have seen an increase in pessimism recently. The stock's SOIR has ground higher from its June 12 reading of 0.68 to its current perch at 0.69, as puts have been added at a faster rate than calls among near-term options.
Wall Street is similarly skeptical of GD, as nine of the 17 analysts following the company rate it a "hold" or worse. Any upgrades from this group could provide additional upside pressure on the security.
Rambus (RMBS)
Call options on Rambus Inc. (RMBS) have become quite the hot property on Wall Street, with volume ratcheting up sharply last week. During the past five days, traders on the International Securities Exchange (ISE) have bought to open 21,451 calls on RMBS, compared to just 7,465 puts. In other words, option players on this exchange have purchased nearly three times more calls than puts during the past week.
As a result, the stock now boasts an inflated 10-day ISE call/put volume ratio of 3.03. However, this reading ranks almost squarely in the middle of its annual range, suggesting that the current bias toward bullish bets is simply business as usual for RMBS.
In fact, the stock's Schaeffer's put/call open interest ratio (SOIR) has actually escalated of late, arriving today at 0.45, in the 83rd annual percentile. This ratio is significantly higher than its June 12 perch at 0.35, in the 49th annual percentile. During the past week, near-term put open interest has surged 63.3%, while comparable call open interest has increased by just 28.9%.
The equity's July 20 and July 17 puts hosted much of the new put open interest, with each strike adding roughly 1,200 contracts during the past five days. Implied volatility on the July 17 put has dropped from 80.4% on Monday to 74.4% by Friday's close, though, suggesting that sellers could be responsible for some of the new open interest at this strike.
Likewise, implied volatility on RMBS' July 20 put has dwindled throughout the week from 80.5% to 75.0%, indicating that the influx of open interest here was not the result of newly purchased bearish bets.
With RMBS trading squarely between these two strikes at last check, potential put sellers are gravitating toward both in-the-money and out-of-the-money options. Meanwhile, call buyers have added roughly 1,100 new contracts at the stock's out-of-the-money July 20 strike during the past week, with implied volatility on the option jumping from 71.3% to 76.9% as a result.
At the same time, short sellers have been rushing for the exits when it comes to RMBS. Short interest on the shares fell by 11.7% during the past month, dropping by 9.3% during the most recent reporting period alone. These bearish bets still account for more than 5% of the stock's float, though, suggesting that some short sellers remain firmly entrenched.
The recent flood of bullishly oriented option volume was sparked by the recent news that RMBS reached a tentative settlement with the European Union (EU) regarding antitrust charges. However, the stock was already performing respectably well on the charts, as evidenced by its 60-day relative-strength reading of 162% versus the S&P 500 Index (SPX).
Specifically, RMBS has cruised higher since late February along the support of its 10-day and 32-day moving averages. The shares could also now find support near the $17 region.
Thanks to its recent show of strength on the charts, RMBS is now poised to finish June on the north side of its 20-month moving average -- a stubborn resistance level that hasn't been breached on a monthly closing basis since May 2008.
As the security maintains its short-term uptrend, a continued migration toward the bullish bandwagon could help RMBS extend its EU-related rally.
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