This Stock's Chart is Screaming Oversold -- Go Long Now!

When a stock reaches oversold levels on the charts without any discernable fundamental reason for doing so, a bullish opportunity often presents itself. That is the case with today's trade, Penske Automotive Group (NYSE: PAG)

The stock is 15% off its July 7 high, and not only has there been a lack of bearish news, the news has been downright bullish.

The second-largest auto dealership group in the United States announced a 5% increase in its quarterly dividend to $0.20 per share in mid-July.

Two weeks later, it reported record quarterly profits, with income from continuing operations increasing 28% from the year-ago quarter to $80.3 million. Earnings per share (EPS) jumped 27% to $0.89, beating consensus estimates by $0.02.

Analysts have steadily increased their full-year earnings projections. They now stand at $3.27 per share for 2014, up from $3.18 three months ago. And 2015 EPS estimates have risen to $3.64 from $3.53 in the past 90 days.

The mean consensus target for the stock is $53.67, more than 20% above the recent price, and no analysts currently have a "sell" rating on the shares.

So, with fundamentals bullish, we turn to the chart where several indicators are screaming oversold.

PAG Stock Chart

I have included Bollinger Bands set at 2 standard deviations, and we can see that shares have fallen below the lower Band. This means they are trading significantly outside their normal trading range.

Additionally, the Relative Strength Index (RSI) and stochastics both indicate severe oversold conditions.

Shares have dipped below their 200-day moving average for the first time since June of last year. While this is usually cause for concern, in the case of PAG, the last time shares fell below this level they immediately rallied more than 30%. Furthermore, there is a strong Fibonacci level below at $42.50, which should offer support.

I am looking for PAG to recover about half of its sell-off from the July high and placing our target at $46.16. Although that's only 5.4% above current prices, we could make 22% in a matter of weeks using my options buying strategy.

PAG Call Option Trade

Today, I am interested in buying PAG Nov 40 Calls for a limit price of $5.05. PAG options tend to have wider spreads, so be patient while waiting for your limit order to be filled.

PAG Call Option
Risk graph courtesy of tradeMONSTER.

This call option has a delta of 71, which means it will move roughly $0.71 for every dollar that PAG moves, but it costs only a fraction of the price of the stock.

The trade breaks even on expiration at $45.05 ($40 strike price plus $5.05 options premium), which is 3% above current prices.

If the stock hits our $46.16 target, the call option will be worth at least $6.16. I expect this to occur within two weeks, but the November options allow us a cushion in case it takes longer. Once you enter the trade, place a good 'til cancelled (GTC) order to sell the calls at $6.16.

Recommended Trade Setup:

-- Buy PAG Nov 40 Calls at $5.05 or less (use limit orders)
-- Set stop-loss at $2.75
-- Set price target at $6.16 for a potential 22% profit in two months 

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

 

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