After bouncing off the lows of $16.50 from May 10, shares of SolarCity Corp (NASDAQ:SCTY) are encountering big-time resistance at the $25 level. I look for the struggle to continue, with SCTY trading sideways at best over the next few months.
Click to Enlarge As the chart shows, SolarCity stock rallied over 50% from the recent May 10 lows to close the Feb. 10 post-earnings gap at the $25 area.
The subsequent failure of SCTY to breakout past the $25 gap on May 24 signifies a strong technical top in SCTY shares.
As an options guy, I like to use implied volatility as a market-timing indicator, with periods of high IV indicating fear and low IV complacency.
Warren Buffett famously said, “Be fearful when others are greedy and greedy when others are fearful.” That same notion can be applied using implied volatility.
A Volatile SCTY
Click to Enlarge High comparative levels of IV are many times indicative of market bottoms, while low levels of IV can signal market tops.
SCTY implied volatility is now at the lowest levels since early January, which marked a significant top in SCTY stock.
I look for this low regime of IV to once again harbinger an intermediate-term top in SolarCity.
Famed short seller Jim Chanos of Kynikos Associates LP is still targeting SCTY as one of his favorite candidates to sell short, stating that the company loses money on every installation.
He thinks SolarCity will run into financial trouble in 2016, especially given the egregious cash burn rate. Certainly the latest earnings report from the company supported the bear case made by Chanos.
So given the technical and fundamental issues facing SCTY stock, I want to take a guardedly bearish stance in SolarCity.
SolarCity Options
Buy the SCTY July $27 calls and sell the SCTY July $25 calls for 30 cents. These are the regular monthly options that expire July 15.
The short $25 call strike is positioned right at the $25 resistance level and provides a 16% upside cushion to the $21.41 closing price of SCTY.
Maximum return on the trade is $30 per spread with maximum risk of $170 per spread. Return on risk is 17.64%.
I would look to cover the position on a meaningful break above the $25 resistance area while looking to have the spread expire worthless and keep the initial $30 credit if SCTY 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.
