Shares of SolarCity Corp (SCTY) have doubled since making a low of $25.02 on Nov. 12, closing at $50.08 yesterday.
Click to Enlarge But the real number of note is $58.87 — where SCTY traded on Dec. 17 before succumbing to selling pressure. And given the recent price action on SCTY, SolarCity stock likely will have trouble moving appreciably beyond $58 in the near-term.
The $58 level has become resistance for SCTY, with shares falling on three previous attempts to significantly break above this area. SolarCity stock also reached an extremely overbought condition on the latest run to $58, with a 14-day Relative Strength Index reading well above 80.
Click to Enlarge Implied volatility has also come down sharply recently, although it still remains relatively elevated.
Short covering can certainly be attributed to some of the veracity of the most recent rally, with short interest at a record 32 million shares (52% of the float) on Nov. 30. Short interest had fallen 7.63% by Dec. 15, indicating a significant drop in overall short positions in SCTY stock.
The U.S. government’s decision to continue providing investment tax credits for solar and other renewable energy, along with the agreement to reduce emissions at the Paris Accord, has certainly benefited renewable solar energy stocks like SCTY.
Whether this benefit is worth a doubling in share price is the real question.
Noted short seller Jim Chanos points to continued cash burn issues, along with high debt-to-equity ratios, as reasons to be bearish on SCTY. He draws the comparison of the SCTY business model to that of the subprime financing during the financial crisis of 2008-09.
Click to Enlarge SolarCity stock is normally correlated to the price of oil, as seen in the accompanying chart.
Since the lows of SCTY stock on Nov. 12, however, that correlation has broken down dramatically, with SolarCity shares rallying by just more than 100% and oil falling by 11.47%.
Unless oil moves sharply higher, this divergence will likely be a strong headwind for SolarCity stock.
| 11/12/2015 | 12/30/2015 | % Change | |
| SCTY | 25.02 | 50.08 | 100.16% |
| Oil | 41.60 | 36.83 | -11.47% |
The magnitude of the recent rally in SCTY stock — along with the technical resistance, fundamental challenges and short covering — is what has me so sure that SolarCity won’t get past $58.
To position to profit, I would look to sell an out-of-the money call credit spread, selling the SCTY Feb $60 calls and buying the SCTY Feb $65 calls for a 70-cent net credit.
The $60 short strike is above the $58 resistance level and provides a 14.17% upside cushion to the $50.80 closing price on SCTY. The maximum gain is the $70 net credit received, while the maximum risk is $430. Return on risk is 16.28%.
I would cover the position on a meaningful move above the $58 resistance level, while letting the spread expire and keeping the initial $70 credit if SCTY stock remains well-behaved.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
