After rallying 67% from the March 29 lows of $21.01 to the April 22 high of $35.23, shares of SolarCity Corp (SCTY) have fallen 25% to close at $26.45. It is now fast approaching major support at the $24.50 level, with further support at $21. I look for SCTY to hold this level over the next month.
Click to Enlarge In a previous article from March 11, I was somewhat skeptical of SCTY being able to move appreciably higher, especially with oil trading at $38.49 then and the stock trading at a premium to the price of oil.
That viewpoint proved to be correct. With oil having risen 14% since that date with SCTY stock remaining at nearly the same price as it was on March 11, SolarCity is now trading at a large discount to oil.
This divergence should realign, providing a relative floor for shares of SCTY going forward.
Click to Enlarge From a technical perspective, SCTY stock is getting oversold. Bollinger Band Percent B, which measures the relative position of the stock within the bands, is close to turning negative.
Previous instances when this metric reached comparable levels proved to be prescient in identifying short-term lows in SCTY stock.
Most importantly, implied volatility (IV) remains extremely elevated, with readings well over 100. This definitely favors option selling strategies that can provide a big price cushion with defined risk.
SCTY Stock Trade
Click to Enlarge To structure the trade, I am looking out to the monthly June options that expire June 17 with strikes well below the current level of SCTY stock.
Specifically, I would look to sell the June $20 puts and buy the June $18 puts for a 60-cent net credit or better. Maximum gain on the trade is $60 per spread with maximum risk being $140 per spread. Return on risk is 43%.
Perhaps most importantly, breakeven on the trade is $19.40, which provides a $7.05 downside cushion (26%) to SolarCity’s Tuesday closing price of $26.45. The short $20 strike is also positioned below the two support levels of $24.50 and $21.
I would look to close out the position on a meaningful break of the lower $21 support level, while letting the spread expire worthless and keeping the $60 initial 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.
