Shares of Shake Shack (NYSE:SHAK) have exploded higher recently. Shake Shack stock is up 16% over the past three days following a positive note from Goldman Sachs and a massive upside squeeze in heavily shorted names like SHAK. Now that the shorts have been squeezed hard, any further upside may be limited for Shake Shack stock. That means it’s time to short the burger joint on any rally.
The impetus behind the recent run up was a note from Goldman Sachs maintaining a “buy” rating and a $115 price target. The fact that the higher price target was released during one of the biggest short squeezes in recent market memory is probably just coincidental.
One of the main drivers of the bullishness mentioned in the note was that chicken nuggets will be staying on the menu. Apparently that is cause enough for a massive move higher. You really can’t make this stuff up.
Shake Shack stock is getting extremely overbought on a technical basis. The 14-day relative strength index is above 70 and nearing the highest levels of the year. The last time it was at such lofty levels marked a significant short-term top in the stock. Moving average convergence/divergence just ripped past 1 and is also at an extreme. Bollinger Percent B echoes the euphoria as well with a reading over 120. SHAK is now trading at its largest premium to the 20-day moving average since it came public.
There is major overhead gap resistance at the $72 area. Shake Shack stock has failed to pierce this level over the past two trading days. The shorts may have to cover, but the longs look like they are refusing to take SHAK appreciably higher. The post-earnings gap should provide for a formidable headwind going forward, especially given the magnitude of the recent red-hot rally. Let us not forget that same-store sales slowed to just 2% growth last quarter versus expectations for 2.5% improvement.
The options market is also displaying some upside euphoria as well. Wednesday saw over 104,000 total call options trade compared to the previous average call volume of just under 3,000. Nearly half the volume (48,404) was in out-of-the money call options that expire today, Jan. 17. This undoubtedly smacks of highly speculative positioning. It also is the hallmark of a speculative top.
All of this option volume drove implied volatility to the highest level since just before the last earnings report. This means option prices are comparatively expensive, favoring option selling strategies when constructing trades. So to position to be a seller on a further rally, a short-term, out-of-the money bear call spread makes intuitive sense.
How to Trade Shake Shack Stock
The Jan 31 $73/$75 call spread can be sold for 60 cents net credit. Maximum gain on the trade is $60 per spread with maximum risk of $140 per spread. Return on risk is 42.9%. The short $73 call strike is positioned just above the $72 resistance area and provides a $2.57 upside cushion to the $70.43 closing price of Shake Shack stock. It also expires before the earnings report due in early February, thus eliminating any earnings-related risk.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in receiving finding out more about unusual option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at firstname.lastname@example.org.