The S&P 500 hit a new intraday high last Friday before pulling back and closing lower. While I think the bullishness will continue, taking a bearish position on e.l.f. Beauty, Inc. (NYSE:ELF) seems like a good way to protect against a larger potential pullback.
Daily Chart of S&P 500 Index (SPX) — Chart Source: TradingView
If you look at the chart of the S&P 500, you can see that on Thursday, before the market pulled back, the index’s relative strength indicator (RSI) was at 71, meaning the market was overbought.
As my regular readers know, traders often use indicators such as the RSI to determine whether a stock or index is in “overbought” or “oversold” territory.
Typically, an RSI reading above 70 tells traders that an asset is overbought, or overvalued, while a reading below 30 tells traders that an asset is oversold, or undervalued.
When the market was overextended in November, the index fell by 3% and then recovered, which is a healthy pullback for a bullish trend.
It’s worth noting that the RSI before the pullback in November was higher than right now, and Friday’s pullback wasn’t as severe.
With a bearish trade on ELF, traders can profit from a pullback, and they may not have to wait long for ELF to fall.
ELF Started 2020 with SEC Issues
This company has a habit of starting the new year off with troubling news, though 2020 was admittedly better than 2019.
Last January, ELF self-reported that it had unknowingly imported $4.4 million in fake eyelash kits from a Chinese supplier that had sourced materials from North Korea. The U.S. Treasury Department fined ELF, and the stock lost value.
The 10-K is a form companies submit to the SEC, disclosing an overview of their businesses and financial condition. It often includes audited financial statements.
While nowhere near as serious as importing goods that had partial origins in North Korea, the SEC’s request for clarification presented investors with uncertainty, and that pushed the stock down.
Because of ELF’s technical picture, I think it will have trouble recovering, and in the event of a market selloff — regardless of whether it is technical or related to global concerns — this stock could be in for more downward movement.
ELF’s New Resistance Above $16
In the chart below, you can see that ELF pushed higher over 2019, breaking above $15 per share in early July. For the rest of the year, the stock managed to stay above that level. After reporting earnings in November, the stock fell. Because it beat both revenue and earnings expectations, it’s possible investors wanted to take profits. The stock had gained over 100% since the start of the year.
Daily Chart of e.l.f. Beauty, Inc. (ELF) — Chart Source: TradingView
Since falling, ELF has established new resistance just above $16, and the SEC news didn’t help. While I don’t necessarily believe the stock is going to fall to its early 2019 levels, it could head lower and retest support at $14.50.
Buying a put option at $15 is a cheap way to take advantage of the situation, and it will give traders some downside protection in their portfolios.
Buy to open the e.l.f. Beauty, Inc. (ELF) May 15th $15 Puts (ELF200515P00015000) at $1.70 or lower.
InvestorPlace advisor Ken Trester also brings you Power Options Weekly, which delivers 5 new options trades and his latest trading advice to you each Friday. Trester has been trading options since the first exchanges opened in 1973 with a winning streak that goes back to 1984 with money-doubling average annual profits since 1990.