Shares of Zoom Video Communications (NASDAQ:ZM) finally ran into some resistance yesterday after a monster rally. ZM stock has undoubtedly benefited from the covid crisis as companies look to hold meetings online. The benefit, however, is being more than reflected in the price of ZM. Look for an overvalued and overbought ZM stock to pullback as the novel coronavirus crisis begins to show signs of improvement.
Zoom’s stock is certainly not cheap from a fundamental basis. The current price-to-sales ratio is over 68 and at the highest level of the past year. Other valuation metrics, such as price-to-earnings and price-to-book, are at similar nosebleed extremes. The stock is trading at a 400 P/E on a forward basis with a PEG ratio of nearly 12.
To say ZM stock is priced for perfection is an understatement. It will be difficult to justify these ridiculous multiples once the corona-fueled growth slows and the lockdown lightens. This is especially true given the increased competition by heavyweights such as Facebook (NASDAQ:FB), Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).
InvestorPlace contributor Patrick Sanders took a deep dive on the competition in his May 4 analysis. He notes that all three competitors have seen upticks in adoption of their platforms over the past several weeks. Mr. Sanders goes on to note that Google will be giving away the newly launched Meet video platform for free. This threat of increased competition by industry giants at reduced pricing will undoubtedly serve to slow growth and lessen margins for Zoom. We all know the usual outcome when you go against the likes of Facebook, Microsoft and Alphabet.
Examining the ZM Stock Chart
The technicals are finally flashing red for Zoom stock. ZM reached overbought readings on a 9-day RSI basis before turning lower. Its Bollinger Percent B approached 1o0, then headed down. The MACD also neared recent highs before softening as well. ZM stock is trading at a big premium to the 50-day moving average, which has led to pullbacks to that average in the past. There is major resistance at $170 now.
Most importantly, ZM stock finally had a reversal day. Shares tried to make new all-time highs near the open yesterday, but quickly turned lower. Zoom ultimately closed over 10 points lower on the day and near the lows. This type of price action is often a sign that the rally has come to an end. It is even more powerful given that it took place near all-time highs and after a major move higher. The buyers are likely exhausted and the sellers have taken control.
Option implied volatility (IV) is still high in Zoom. This favors selling strategies when constructing trades. So to position for a pullback in the stock using a defined risk bear call spread makes sense. This is a safer way to take a short position in ZM stock in place of shorting the shares outright. It is even more important given that earnings are due June 2, which could increase volatility in Zoom .
How to Trade Zoom Now
Sell the ZM June $180/$185 call spread for $1.70 net credit.
The maximum gain on the trade is $170 per spread with maximum risk of $3.30 per spread. Return on risk is 52%. The short $180 strike price provides a 9.3% upside cushion to the $164.69 closing price of ZM stock. It is also above the all-time closing high of $174.83. I would use a meaningful break past the all-time intra-day high of $181.50 as a stop out point to close the position from a risk standpoint.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.