In last week’s edition of Trading Tools, Comcast Corporation (CMCSA) was analyzed after the Zacks Unusually High Option Volume screener revealed a spike in pre-earnings pessimism. Employing the same filter for today’s column, a different security caught my eye: Overland Park, Kan.-based communications concern Sprint Nextel (S).

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.

According to the Zacks screener, call speculators swarmed S on Thursday. The equity saw roughly 33,300 calls change hands, tripling its average daily volume of fewer than 11,000 contracts.

The Strategy

It appears that a trader may have opened a calendar spread on the security. The Aug 4 call added more than 2,400 new positions, lifting its open interest to 58,178 contracts. At 11:36 a.m. Eastern time, a block of 2,500 contracts crossed the tape at a bid price of 12 cents. Meanwhile, the Sep 4 call traded a block of 2,500 contracts at the same time at an ask price of 28 cents.

A calendar spread (or, as it is sometimes called, a “horizontal spread”) takes advantage of time decay, through the simultaneous purchase and sale of options with the same strike price, but different expirations. Calendar spreads benefit from time-value differentials during periods of reduced volatility (i.e., trading-range environments). Typically a neutral strategy, this spread can have a bullish or bearish bias as well, depending on the options employed. If a trader has a slightly bullish bias, he will use calls, while a trader with a somewhat bearish bias will use puts.

A trader wishing to buy or “go long” using a calendar spread, as in the case of the S trader Thursday, would buy the longer-dated option and sell the shorter-dated one. This move would also be considered a debit spread, since the option being purchased costs more than the one being sold, requiring a net cash outlay even before commissions.

Conversely, calendar spreads can also be sold (with the trader “going short”) where the earlier-dated option is purchased and the later-dated position of the same type (i.e., put or call) is sold.

Net losses are limited to the premium paid at the time the spread is initiated, while the maximum profit is dependent upon the time value in the longer-dated option at the time the shorter-term contract expires.

In the case of the trade above, it appears that the trader is looking for the shares of S to remain below the 4 strike during the next week so that the Aug 4 call expires worthless.

A Look at the Charts

Technically speaking, shares of S have fallen on hard times recently. Since reaching a peak of $5.94 in May, the security has pulled back more than 34%. Along the way, the stock has created a series of lower highs and has drifted lower under its 10-day and 20-day moving averages. In addition, the equity has dropped below its 10-week and 20-week moving averages, which have been pulled into a bearish cross. This technical formation indicates a shift in the stock’s intermediate-term trend.

From a longer-term perspective, the equity’s 20-month moving average is declining into the region and could cap any rally attempts. S has not logged a monthly close above this trendline since August 2007.

The Sentiment Backdrop

Considering the stock’s lackluster performance, it’s not surprising to see that Wall Street doesn’t exactly have a lot of faith in the stock. According to Zacks, the stock has earned six “buy” ratings, eight “holds” and one “sell”. This configuration leaves ample room for potential downgrades should the equity continue to grind lower.

Meanwhile, despite Thursday’s call buying, options players are increasing their put trading on the International Securities Exchange (ISE). The ISE 10-day put/call volume ratio comes in at 0.32, which is higher than 72% of all those taken during the past year.

However, the Schaeffer’s put/call open interest ratio (SOIR) for S currently rests at 0.32, indicating that calls significantly outnumber their put rivals among near-term options. What’s more, the security’s SOIR ranks in the 10th annual percentile, meaning short-term speculators have been more bullishly biased toward S only 10% of the time during the past year.

In conclusion, the stock needs to win the looming battle with its 20-month moving average in order to stay in the bulls’ good graces. A rejection at this trendline could spook a mass exodus in the bullpen, which could place additional selling pressure on the shares.

Zacks Investment Research