A Closer Look at... Seagate Technology, Western Digital, and NetApp Inc.

              

The computer hardware sector started 2010 off with a bang, but the group has since fallen on hard times. In fact, the NYSE Arca Computer Hardware Index (HWI) has shed more than 5% on a year-to-date basis, compared to the tech-laden Nasdaq Composite's (COMP) loss of about 1.5% for the same time frame. What's more, HWI's downtrend could be gaining momentum, as the index has pulled back below its 160-day moving average, with this trendline rejecting the shares soundly earlier this week.

Despite its poor performance, investors remain bullishly aligned on the hardware sector. For instance, more than half of the 913 ratings on hardware sector stocks are "buys" or better. As HWI's price action weakens, these bulls could be forced into abandoning their losing positions, thus resulting in additional downward pressure on the sector.

Seagate Technology

Within the hardware sector, Seagate Technology (STX) is a prime example of the group's poor performance. After the close on July 20, STX posted a fourth-quarter profit of 76 cents per share, missing the consensus estimate by 2 cents per share. The stock responded by plunging more than 9.5% the following session. But STX's poor price action began long before the company's poor quarterly results hit the Street. In fact, the stock is sitting on a year-to-date loss of more than 30%, far outpacing the COMP's loss for the same period.

Since late April, STX has been pressured lower by resistance at its declining 10-week moving average. The stock has not closed a session above this intermediate-term trendline during this time frame. Currently, STX is reeling from its latest rejection at its 10-week trendline, with the shares breaking out to fresh multi-week lows below former support at the $13 level in the process.

On the sentiment front, no less than five analysts have cut their price targets on STX, while Brean Murray Carret and S&P Equity Research downgraded the stock to "hold" from "buy." There is still plenty of room for other brokerage firms to follow suit, as Zacks reports that 13 of the 23 analysts following the stock still rate it a "buy" or better. What's more, Thomson Reuters reports that the average 12-month price target for STX rests at $23.86 per share - a whopping 90% premium to the stock's current trading range near $12.50 per share. Additional downgrades or price-target cuts could create additional headwinds for STX.

The situation is much the same outside of the analyst community. STX's Schaeffer's put/call open interest ratio (SOIR) of 0.55 ranks below 83% of all those taken in the past year. What's more, this optimism is far from waning, as data from the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) point toward continued call buying. Specifically, the current 10-day ISE/CBOE call/put volume ratio of 3.71 indicates that calls bought to open have nearly quadrupled puts purchased during the prior two weeks. As STX continues its downtrend, an unwinding of the hedges related to these calls could pressure the stock steadily lower.

Finally, short interest has plunged nearly 19% during the past month, resulting in about 21 million STX shares sold short. Despite this added buying pressure, the equity has persisted in its trend lower, indicating that selling pressure is far from waning on STX. Traders looking to take advantage of an extended sell-off for STX should consider the stock's September 14 put.

Western Digital Corp.

Western Digital Corp. (WDC) followed STX into the earnings confessional on July 21, with the hard-disk manufacturer reporting a fourth-quarter profit of $1.13 per share. While the figure was solidly above the prior year's earnings of 86 cents per share for the same quarter, WDC missed the consensus estimate by a quarter per share.

Technically speaking, the shares plunged nearly 16% in the wake of the report, extending WDC's year-to-date loss to more than 40%. The shares have been pressured lower by their declining 10-day and 40-day moving averages since late April, and are poised to slip beneath long-term support in the $27 region. A move below this area of technical support could be a sign that WDC is far from reaching a near-term bottom.

From a sentiment perspective, WDC investors are shifting quickly toward the bearish end of the spectrum. For instance, options traders are piling into put positions. The stock's ISE/CBOE 10-day put/call volume ratio of 2.07 indicates that puts bought to open have more than doubled calls purchased during the prior two weeks. That said, the stock's SOIR of 1.19 ranks near the midpoint of its annual range, meaning that the bearish bandwagon is far from being overcrowded.

What's more, despite a 25% decline in the number of shorted shares during the past month, WDC shares have extended their run lower. With the stock practically in free-fall mode, some of these bears may begin to return to WDC, thus creating additional pressure on the security. Traders looking to bank a profit on WDC's eroding price action should consider a September 30 put.

NetApp Inc. (NTAP)

Not every member of the computer hardware sector should be tossed in the recycle bin, however, as evidenced by NetApp Inc.'s (NTAP) year-to-date rally of more than 25%. According to the company's website, NTAP's targeted earnings date is Aug. 18. Currently, Wall Street analysts are looking for a profit of 36 cents per share, up sharply from last year's profit of 7 cents per share in the same quarter. Historically, NTAP has bested the consensus estimate in three of the prior four reporting periods, with an average upside surprise of 8.03%.

Despite NTAP's solid fundamentals, options traders have set the bar pretty low for the firm. Specifically, the security's SOIR of 1.68 indicates that puts outnumber calls among near-term options. This ratio also ranks above 89% of all those taken in the past year, indicating low expectations from options traders.

What's more, NTAP's 10-day ISE/CBOE put/call volume ratio of 0.97 ranks above 73% of all such readings taken in the past year. With put buying nearing an annual extreme, one could argue that speculative investors have set their sights below Wall Street's consensus earnings estimate. As such, a positive reaction to the company's quarterly report could send these bears scrambling for the exits, thus applying additional upside pressure to the security.

Options traders aren't alone in their negative outlook for NTAP. For instance, 17 of the 35 analysts following the shares rate them a "hold." Furthermore, short interest jumped by nearly 18% during the past month, and now accounts for more than 4.7% of NTAP's total float. Should the company beat expectations, we could see upgrades and/or short-covering propel the shares sharply higher.

Technically speaking, NTAP has rallied more than 86% during the past year, with the stock's 10-week and 40-week moving averages providing support since the market bottom in March 2009. However, the security was recently rejected at overhead resistance in the $45 region, forcing the shares to pull back to the $42 area - a level that capped NTAP in mid-June and could now switch roles and act as support.

With heavy investor pessimism, a key technical hurdle looming overhead, and an earnings report just over the horizon, trading options on NTAP could get quite dicey - especially if market volatility spikes once again. Checking in with the equity's implieds, implied volatility on the August 42 call arrives at 41%, while implieds on the August 42 put rest at 41%. Comparatively, one-month historical volatility arrives at 42.67%, meaning that these options are relatively inexpensive at the moment. Given this data, an August 42 straddle heading into NTAP's earnings report could be an excellent way to take advantage of a sharp move in either direction for the equity. That said, traders will want to confirm the company's earnings date before entering such a position, as August options expire on the 20th, just two days after the company's "targeted" earnings date.