No. 2 U.S. Pharmacy is My No. 1 Pick Based on the Charts

When a stock has a compelling fundamental story, strong catalysts and a killer chart to back it up, it has the ingredients needed for the "perfect trade."

Today's pick, CVS Health Corporation (NYSE: CVS), has all these factors working in its favor. It is showing solid revenue and earnings growth, while finding ways to distinguish itself from its peers. And the Ebola scare and flu season should also give shares a boost in the near term.

But what really has me excited about this trade is the chart pattern. CVS is on the verge of a major resistance breakout.

Bullish Technical Outlook

The stock has maintained its bullish trend amid a technical breakdown in the broader market. Since peaking in mid-September, the S&P 500 has fallen 7% and is below its 50-day moving average, a key short-term trend indicator. 

During that time, CVS is off just over 1% after Monday's sell-off. More importantly, it only dipped below its 50-day moving average for two days and has been making a run at new highs, testing major resistance at the $82.50 area several times. 

CVS Stock Chart

Even more interesting is the fact that volume has decreased on down days and increased on up days, providing evidence of where the real momentum lies. 

While Monday's decline in CVS did come on higher-than-average volume -- thanks to the high-volume broad market sell-off -- the stock again held its 50-day moving average, and the number of shares traded was on par with Friday, an up day. Both are bullish signs in my book.

Broad market weakness has slowed but not stopped the near-term bullish trend in CVS. With just a little support from the overall market in the form of a bullish day or two, CVS should be able to break through and close above $82.50. This major resistance breakout is likely to propel the stock to the $84.60 area, which represents a key Fibonacci level.

Furthering that technical move, I believe growing Ebola fears and the onset of flu season will act as catalysts for the stock, along with the company's upcoming earnings announcement.

Seasonal and Fundamental Support

Living in Dallas, the location of the first patient to contract Ebola while on U.S. soil, I have witnessed firsthand the visceral panic. With the media fanning the frenzy, people all over the country are truly afraid.

Many Americans will likely be taking extra steps to safeguard their health in the near future. In fact, stores around me are already sold out of anti-viral surgical masks. I know this because I recently contracted the flu, and I made several trips to my local CVS and spent a small fortune on remedies and prescriptions. And I'm the kind of guy who resists going to the doctor and pharmacy whenever possible.

I was certainly more concerned by this illness than usual. And I doubt I'll be the only one who is hyper-aware of their symptoms this flu season or spending extra money to get and stay healthy.

CVS, which operates 7,700 retail pharmacies and services over 5 million customers daily, clearly stands to benefit from this trend. It is the nation's second largest pharmacy behind Walgreens (NYSE: WAG), but I believe the company has an edge thanks to its specialty drug division and walk-in clinics.

Specialty pharmaceuticals represent a huge growth area for the company, and its pharmacy benefits business has helped it capture more of this market than its peers. Revenue from the segment rose 53% in the second quarter of 2014, and now accounts for about 22.5% of its total drug sales. That number is expected to increase to 50% by 2018.

CVS is also the largest operator of retail health clinics in the United States, with 900 MinuteClinic locations and plans for 1,500 locations by 2017. These clinics represent opportunities for the company to increase traffic and sales.

CVS is firing on all cylinders. The company has beat analyst estimates in three of the past four quarters, and its next report is scheduled for Nov. 4. My proprietary earnings algorithm, which examines stock chart patterns, option volatility and volume combined with analyst actions ahead of earnings, shows another beat is likely.

As I said above, I expect a major resistance breakout that will take CVS to $84.60 prior to the earnings announcement. 

My next target, which I think will be driven by heath concerns and positive earnings, is $87.45, another key Fibonacci level. This sits about 9% above current prices, but using a call option strategy, we can leverage that move into 78% potential gains in three months or less.

CVS Call Option Trade

Today, I am interested in buying CVS Jan 75 Calls for a limit price of $7.

CVS Call Option Trade
Risk graph courtesy of tradeMONSTER.

This call option has a delta of 75, which means it will move roughly $0.75 for every dollar that CVS moves, but it costs less than one-tenth of the price of the stock.

The trade breaks even on expiration at $82 ($75 strike price plus $7 options premium), which is 2.4% above current prices.

If CVS hits my first upside target of $84.60, the call options will be worth at least $9.60. Once you enter the trade, place a good 'til cancelled (GTC) order to sell half of your position at that price.

If shares hit my second target of $87.45, the call options will be worth at least $12.45. Place a GTC order to sell the remaining calls at that price.

Recommended Trade Setup:

-- Buy CVS Jan 75 Calls at $7 or less (use limit orders) 
-- Set stop-loss at $3
-- Set initial price target at $9.60 for a potential 37% gain in one month
-- Set secondary price target at $12.45 for a potential 78% gain in three months 

If you have a question or comment about today's strategy, please send it to editors@profitabletrading.com.

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