Shares of Square (NYSE: SQ) closed at new all-time highs Thursday, as SQ stock continues to climb ever higher. After bottoming at the $60 level in late June, Square has added on 15% in just the past few weeks. Like all good things, however, the rally in SQ stock will eventually come to an end — and sooner than later.
The impetus behind the big pop yesterday was an upgrade from Credit Suisse. In a note to clients, analyst Paul Condra raised the stock from “neutral” to “outperform” and increased the price target from $44 to $81, or roughly 15% upside to the $70.32 closing price of Square.
Considering that SQ stock has more than doubled so far this year, just 15% remaining upside to a highly volatile stock seems more like a reason to sell the shares than to buy them.
Certainly, any discussion of traditional valuation metrics doesn’t apply to Square, but it can still be enlightening to examine. Since there are no earnings so far, current price-earnings ratios do not compute. The full year 2020 forward P/E estimates are at a nosebleed 142.
Perhaps the best metric to use is price-sales (P/S), which has risen dramatically ever since SQ stock went public. Current P/S ratio is now near historic highs at jaw-dropping levels well over 10. Growth had better be astronomical to support that kind of ratio.
SQ stock is getting decidedly overbought from a technical perspective. 9 day RSI is over 70, a level that has corresponded with short-term tops in the past. Shares are also trading at a big premium to the 50-day moving average another sign of over-exuberance.
Previous times when Square traded at this large a premium proved to be a sign that a pullback was looming. Yesterday’s price action, with the stock pulling back $1.00 off the intraday highs at $71.32, smacks of a reversal pattern that is often emblematic of a meaningful high in the shares.
Earnings are due August 1, with expectations of 13 cents per share on $760 million in revenue. Implied volatility (IV), as usual, is at high levels in front of the announcement. So to position for a pullback in SQ stock, a put calendar trade makes probabilistic sense.
SQ Stock Trade
Buy SQ Aug $65 puts and sell SQ 03 Aug $65 puts for a 55 cents net debit.
Maximum risk is $55 per spread. Ideally SQ stock pulls back toward the $65 area post earnings to realize the maximum potential gain.
Since we are selling options that expire during expiration week, there is a decoded term structure of volatility edge as well. The longer-term options we are buying are trading at a 50 IV while the shorter term options that we are selling are at a much more richly priced 57 IV.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility.
