The intensely debated health care legislation has become law.

Traders now speculate on how the bill impacts the health care sector. Of the winners and losers, the pharmaceutical companies have come out near the top. Over several years, they will pay $90 billion to help offset the costs of health care reform. But in return, they’ll see huge benefits, including a huge influx of new paying customers.

This is because roughly 32 million new people will now be able to pay for prescription medications through insurance coverage. And, numerous seniors will be able to use Medicare to fill prescriptions that were too costly in the past.

Lucrative biotech drugs — which are more costly for companies to develop because they are made from living cells instead of chemicals — have been granted 12 competition-free years. This is a huge victory for the biotech industry against the generic drug makers, which had been pushing for seven years. The result should translate into higher profit margins for biotech firms.

#-ad_banner-#These are just some of the reasons I like the SPDR S&P Pharmaceuticals (NYSE: XPH) exchange-traded fund (ETF)

The ETF contains 25 pharmaceutical companies. About 70% of the companies in this fund are mid- and small-cap stocks. Top holdings are giants like Johnson & Johnson (NYSE: JNJ) and Pfizer (NYSE: PFE), but it also includes smaller companies like Perrigo (Nasdaq: PRGO), Impax Laboratories (Nasdaq: IPXL) and Valeant Pharmaceuticals (NYSE: VRX). The fund has a net asset value of nearly $90 million.

XPH seeks to replicate the performance of the S&P Pharmaceuticals Select Industry Index. Fundamentally, it is in line with the index. Both XPH and the index have a forward one year price to earnings (P/E) ratio of 13.2, both have an estimated three to five year earnings per share (EPS) growth rate of +16.4%.

But where XPH really shines is in its technical signals.

As the chart below shows, XPH is on a tear. It has been on a steady uptrend since hitting a low of $23.35 in March 2009. From this low, it has gained more than +80% to date.


 

• At the beginning of March 2010, XPH shot past resistance near $40 on high volume. Currently at $41.97, XPH is near its highest point since inception in June 2006. The fund remains well above trendline support, which is just below $40.

• XPH is above its rising 10- and 30-week moving average; because of the December 2009 to February 2010 consolidation, it is not over-extended.

• The indicators confirm the positive trend. MACD has just given a buy signal. The MACD histogram is expanding into positive territory.

• The relative strength index (RSI) has been on a steady uptrend since October 2009. Although RSI shows the ETF is overbought, strong securities can remain overbought for extended periods of time.

• Stochastics confirms that XPH is overbought. However, it remains on a buy signal, giving further credence to the fact that strong securities can remain overbought for long periods.

With no resistance in sight, this security can soar. I am setting my target at $49.95, just below the round resistance number of $50. My stop-loss is $36.25 — below trendline support and the December to February consolidation.

Action to Take: Based on the analysis above, here’s how I plan to trade XPH:

• Purchase XPH on Monday, March 29th
• Set the stop loss at $36.25
• Target price = $49.95
• Potential Profit = +19.0%