Bullish prescription for Forest Laboratories (FRX)

Despite the wave of buying pressure sweeping across Wall Street since the March bottom, traders have had to seemingly drag the pharmaceuticals sector screaming and kicking higher. Specifically, the AMEX Pharmaceuticals Index (AMEX: DRG) has added a mere 5.4% since the beginning of the year, compared to the S&P 500 Index's (SPX) gain of more than 17% for the same period. However, there is potential for the group to gain momentum as the economic recovery picks up the pace.

On the technical front, DRG maintains key support at its 10-week moving average, and has recently overtaken former support in the 280 region. Meanwhile, there is ample sideline money available to push the sector higher. The composite Schaeffer's put/call open interest ratio (SOIR) for DRG components rests at 0.82, in the upper half of its annual range. Elsewhere, composite short interest for the pharmaceuticals sector rests near its highest level of the past year. An unwinding of these short positions could provide additional buying pressure.

Among the most promising of DRG's holdings is Forest Laboratories Inc. (NYSE: FRX, Stock Forum). The shares have gained a mere 14.6% since the start of 2009, but momentum has built during the past several months. Specifically, FRX has soared more than 69% since bottoming near $19 per share in mid-March.

Throughout the majority of this rally, the shares have enjoyed the support of their rising 10-week moving average. In fact, this intermediate-term trendline has helped push FRX above formerly staunch resistance at the 27 level. Currently, the security is being pinched between support at its 10-week moving average and short-term resistance in the round-number 30 level.

Fundamentally, FRX has been even more impressive. For instance, the company has bested Wall Street's earnings estimates in each of the prior four reporting periods. Additionally, the firm has toppled these expectations by an average of 14.7%. Looking ahead, FRX should release its latest quarterly earnings report near the end of October. While the company has yet to set an official date, analysts have already set their sights on a profit of 85 cents per share -- a five-cent improvement over the same quarter last year.

On the sentiment front, opinions are shifting toward FRX. Among options traders, bullishly oriented calls are gaining favor, as the stock's 10-day International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) call/put volume ratio arrives at 5.25. This reading indicates that calls bought to open have more than quintupled puts purchased on these exchanges during the prior two weeks. What's more, there is plenty of room for this bullish trend to continue, as FRX's Schaeffer's put/call open interest ratio (SOIR) of 0.75 arrives higher than 71% of those taken during the past year.

There is also room for improvement from Wall Street analysts. Specifically, the equity has garnered just six "buy" ratings, compared to 11 "holds" and one "sell." Furthermore, Thomson Reuters reports that the consensus 12-month price target for FRX rests at $29.60 per share, a mere 40 cents above the stock's Monday close at $29.20 per share. With heavy pessimism from investors and a strong technical backdrop, bullish contrarian investors appear to be on solid footing heading into FRX's quarterly earnings report.

Disclosure: Joseph Hargett has no financial interest in any of the equities or products mentioned in this column.

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