Meritage Homes (MTH)

In last week's edition of Trading Tools, e-learning company SkillSoft (SKIL - Snapshot Report) was examined, as it appeared on the Zacks Put/Call Ratio Greater than 1.0 filter. Utilizing the same screener this week, one equity caught my eye: building behemoth Meritage Homes (MTH - Snapshot Report).

Before we begin, let's explain the contrarian stance that makes Schaeffer's so unique. When searching for a bullish pick, we like to see heavy skepticism toward an outperforming stock, as this leaves ample room for upgrades or other positive catalysts to fuel the stock higher. When searching for a bearish pick, on the other hand, contrarians are looking for significant bullish sentiment toward an underperforming stock, as we believe an excess of optimism is a sign that everyone has already bought into the stock and sideline money is virtually tapped out.
However, keep in mind that some optimism and pessimism is genuinely warranted and isn't always a contrarian indicator – like an outperforming stock with many "buy" ratings or an underperforming stock with a plethora of "sell" ratings.

The Put/Call Ratio Greater than 1.0 Screener

First, an explanation on our stock screener. The filter looks for stocks with a high put/call open interest ratio, indicating puts outnumber their call counterparts amongst near-term options. Why is this important? Simply put, a high Schaeffer's put/call open interest ratio (SOIR) – measuring options slated to expire within 3 months – suggests that expectations for the security to rally are extremely low. In other words, a high ratio usually indicates pessimism amongst short-term options speculators.

From a contrarian perspective, we are looking for a stock that has low investor expectations (such as heavy put trading) and a strong technical performance. This combination of strength on the charts and skepticism among option traders leaves substantial room for continued upward momentum should these bearish bets unwind.

The Summit of Skepticism

As mentioned above, MTH caught my eye due to its unusually high SOIR. More specifically, the stock's SOIR currently stands at 3.35, indicating that puts more than triple their call counterparts among the front-3 month series of options. What's more, this configuration marks an annual pessimistic peak. However, the skepticism displayed in the SOIR is nothing surprising, considering that about 3.5 times as many puts than calls have been bought to open on MTH during the past 10 days on the International Securities Exchange (ISE).

So, is the pessimism warranted?

Building Technical Strength?

From a technical perspective, the shares of MTH have suffered during the past few years, led lower beneath resistance from their 10-month moving average. However, since January 2008, the stock has managed to pare some of its losses, and now boasts a year-to-date gain of 62%. The security is now poised to close the month atop its 20-month trendline for the first time since early 2006, before this duo made a bearish cross. Furthermore, MTH has been a star compared to the broad market recently, outperforming the S&P 500 Index (SPX) by more than 56% during the past 40 trading sessions.

Word on the Street

Despite MTH's recent run higher, analysts are also in the bears' lair. According to Zacks, the security harbors only 1 "buy" or better rating, compared to 3 "holds." Any upgrades and/or price-target increases in light of MTH's recent uptrend could act as potential catalysts even higher.

In parity with the pessimism among option traders and brokers is the sentiment in the short-selling arena. Short interest on the equity accounts for 7.63 million MTH shares, or roughly 27% of the stock's total available float. Should the shares continue their recent journey into the black, the shorts could get spooked into buying back their bearish bets. At the stock's average daily trading volume, it would take about 8 days for a short-covering rally to ensue, placing potential buying pressure on the equity.

The Bottom Line

MTH followers should keep an eye on the stock's 20-month trendline, as a monthly close atop this moving average would be a feat not accomplished in more than 2 years. However, more importantly, investors should pay attention to the pessimism surrounding the outperformer. A continuation of MTH's voyage into the black could motivate the bears to reevaluate their positions. An unraveling of skepticism – whether in the options pits, brokerage community, or short-selling realm – could help to exacerbate the stock's recent gains.