Catch the Applied Optoelectronics Inc Falling Knife With Confidence

One analyst downgrade is another investor's opportunity. Go Long AAOI on this dip

A Downgrade Wounded AAOI Stock, but Trump Could Kill It

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Applied Optoelectronics Inc (NASDAQ:AAOI) is falling 6% on a negative write-up from Rosenblatt Securities where they post a “sell” rating and lower price target to $30 per share. Luckily, the stock came into this morning up 20% year-to-date. So a small dip won’t kill the momentum.

However, this is not to say that AAOI is on a tear. The stock is still trying to recover from a difficult 2017. In January of 2017, the stock more than tripled in just six months. But soon there after game most of it back and this dip puts it further in the whole. But mathematically, this is the process of an extreme set of circumstances reverting back to the mean.

Today’s 30% downgrade in price is harsh and reminds me of the downgrade to $25 per share that Micron Technology, Inc (NASDAQ:MU) suffered recently.  Sure, AAOI stock may have its overzealous fans but between these two extremes lies the truth. I profited from the MU dip and I believe I can profit from this one.

AAOI is a momentum stock and often enough, both their bulls and bears overshoot in either direction. This creates trading opportunity for those who are willing to take the calculated risk.

No, I won’t step in front of a moving train and buy the shares of AAOI outright without any protection. Instead, I use AAOI options where I can take the risk of catching this falling knife but while wearing metal gloves.

Fundamentally, AAOI is not bloated like momentum stocks can often be. It sells at an 18 price-to-earnings ratio and a 2.5 price-to-book. So owning shares at a discount from today’s dip won’t likely be a financial debacle. This is important to the way I trade because if I am wrong about this I will own shares but lower.

Technically, AAOI had been setting higher lows trying to mount a rally to close a gap from last October. So as long as the bulls can defend the $39 per share area those efforts are still alive. Then above $49.50, it could reignite another leg higher that could target to fill the gap completely.

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Although this is a logical scenario, it is not one that I need to profit from my trade set up today. I merely need AAOI prices to stay above proven support so I can retain my maximum gains. If a rally ensues then my profits will come faster. I am not required to hold my position open through expiration. Since I consider this a speculative trade inside a conservative portfolio, I can close it for partial gains or losses at any time.

AAOI Stock Trade Ideas

The Bet: Sell the AAOI Dec $22.50 put. This is a bullish trade for which I collect 75 cents to open. I have a 85% certitude that I will retain maximum gains. But if the price falls below my strike then I own shares. I would then need to manage off my break-even point of $21.75.

Selling naked puts carries big risk especially for a momentum stock like AAOI. For those who want to mitigate it, they can sell a spread instead.

The Alternate Bet: Sell the AAOI Dec $22.50/$20 bull put spread where I have the same odds of winning. Then the spread would yield 15% on risk.

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Nicolas Chahine is the managing director of As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.

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