What to Short When You Can't Short Financials

It has been, and continues to be, a disastrous situation for financial stocks. As the year has progressed, the market's concerns began over writedowns shifted to concerns about the magnitude of the writedowns, to the most recent concern of the whether these companies were viable at all. The answer to the last is obviously they are not, as all the major investment houses are either bankrupt, no longer independent or looking for options rather than stay investment banks. Since we can't short these stocks anymore, there may be another way to take advantage of this weakness through another sector also impacted by weakness in the financials.

The issue we want to discuss for a moment is the "collateral damage" to businesses because of these companies' failure and continued problems. It takes technology to run these large-transaction and heavily regulated businesses. Now that so many are no longer around and the rest are seeing business shrink, what happens to the technology companies providing these firms with their technological infrastructure? These are big contracts that are disappearing, and with existing clients falling like flies, the possibility of growth or up-selling these customers has also become impossible.

In fact, a large percentage of revenue for technology companies as a whole comes from the financial sector. The financial sector is the largest buyer of tech goods and services. One tech sector that is heavily impacted by these changes is the outsourced technical firms located in India. With financial companies not spending at the same levels and further planned cutbacks, these companies are taking a major hit to their business.

Cognizant Technology Solutions

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As we would expect, the price configurations of these IT outsourcing companies are deteriorating and remain vulnerable to further decline. We will focus on Cognizant Technology Solutions (CTSH - commentary - Cramer's Take). The stock has spent most of 2008 trading in a wide loose range between $26 and $36. This trading range, however, has occurred in what was already the beginning of a downtrend that had begun after a multiyear advance. That is what we like to call a change.

In this case, a change for the worse. The recent selling pressure in the market has led CTSH lower and broken the $26 level, taking it down to the year's lows in the $24 area before a minor bounce in recent days. This is a deteriorating and vulnerable configuration. We would use the strength, or further strength, back to $28 as an opportunity to sell this stock short, looking for a possible decline to the upper teens. The trade can be stopped out on a move above $29, or if traders are looking for a looser stop, above $30.

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At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned. Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.