The saying goes that falling knives are hard to catch. But I also believe that shooting stars (my own term for hot-running stocks) such as Salesforce.com, Inc. (NYSE:CRM) are just as tricky to trade, especially when they’re aggressively valued. CRM stock certainly qualifies given its 20% gains year-to-date, as well as its 475 price-to-earnings ratio.
Anyone who buys Salesforce at this juncture is definitely taking a gamble and should exercise extra caution. To me, CRM is only worth trading via options.
Buying CRM stock at these altitudes leaves traders open to getting to the party late. We’d just be buying someone else’s profits. That’s too large a risk. However, if I could buy Salesforce lower, I’d be willing to make a bullish bet.
And therein lies today’s thesis.
I want to sell downside risk against levels of support. If they hold, I would be creating income out of thin air. I get paid to open a trade, so there would be no out of pocket expense. I also would build a sizable buffer from current prices, thereby giving me some room for error.
Fundamentally, I believe Salesforce stock is as expensive as they get. Traders give the cloud company a pass because of its growth trajectory and a slick CEO who successfully sells us on how great CRM is. I remain somewhat skeptical, but that won’t stop me from betting alongside him.
Click to Enlarge Technically, CRM stock is coming into a 40% rally off a double bottom from last November. There is no obvious technical reason to short it. So I will continue to assume that the upward trajectory should persist and that the support levels should hold.
I see a pivot zone around $86 per share. Pivot zones tend to create a traffic jam as both bulls and bears fight for the advantage. If CRM falls to that zone, the zone likely will provide support.
That’s a thesis I can monetize by selling puts behind it.
How to Trade CRM Stock
The Trade: Sell Oct $82.50 naked put for 90 cents to open. I have a 90% theoretical chance of price staying above my strike, which would allow me to keep my maximum gains. If shares fall below the strike price, I’ll become an owner, and I’d start to suffer losses below $81.50.
However, selling naked puts requires margin and opens risk all the way down to zero. If you’re more risk-averse, consider selling spreads instead.
The Moderate Trade: Sell the Oct $82.50/$80 put spread for 40 cents. The yield from the spread if successful is 18%, which is impressive given that the risk is much more finite than selling naked puts.
In either trade setup, I merely need CRM stock to stay above $82.50 per share to win. Thus, Salesforce could theoretically fall 10% from here and I would still profit. This is a much more comfortable proposition than risking nearly $92 per share to buy CRM outright and hope it rallies.
Investing in the stock market is risky, so never bet more than you are willing to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
