Shares of Chinese electric car maker Nio (NYSE:NIO) have certainly been on a run lately. NIO stock has gained more than 125% since the latest red-hot rally began on Oct. 13.
Some of the run-up was warranted given the improving demand for electric vehicles, especially out of China. Shares have now come too far, too fast, however. Time for Nio stock to put on the brakes.
InvestorPlace Senior Investment Analyst Luke Lango took a deep dive into Nio’s Nov. 17 earnings release. He noted the strong revenue and delivery growth along with margin expansion and came out with a $150 price target for 2030. Luke also mentioned that Nio stock dropped following that robust earnings report.
Part of this may have to do with a reality check. Although revenues did rise a very strong 160% year-over-year, the price of NIO rose almost 2,400% in that same time frame. This means that Nio stock rose 15 times more than Nio sales did. This puts the current price-to-sales (P/S) multiple at 37x, its highest reading ever. Longer term, NIO may very well indeed hit the $150 price target. Shorter term, Nio stock will likely continue to consolidate.
Technical Take on Nio Stock
NIO once again reached extremely overbought levels before weakening. Nine-day RSI broke above 80 but has since retreated. MACD printed at the highest levels of the prior six months then dropped sharply.
Momentum, a key component for Nio stock, got to an extreme but subsequently pulled back strongly. Shares were trading at a big premium to the 20-day moving average before leveling off. Previous instances when these indicators aligned in a similar fashion marked significant short-term tops in Nio shares.
Source: The thinkorswim® platform from TD Ameritrade
More importantly, NIO saw a key reversal day on Nov. 13. The shares traded to new all-time highs at $54.20 before being pounded back to close nearly 10 points off the high (and lower on the day) at $44.56.
This type of price action is many times indicative of a top in the stock. The buyers have finally become exhausted and the sellers have taken control. It is an even-more powerful reversal signal given that it took place at all-time highs and following such a massive rally.
Volatility View
The recent rally in Nio stock has also caused the skew between puts and calls to reverse. Normally out-of-the money puts trade at a higher implied volatility (IV) to similarly out-of-the money calls. That relationship has changed recently with calls trading at an IV premium to puts.
The table shows the Jan $55 calls at a 109.13 IV while the Jan $43 puts at just a 105.85 IV. This inversion was likely caused by a big demand pick up from call buyers and is a sign of overexuberance. It is also a very reliable contrarian indicator.
Source: The thinkorswim® platform from TD Ameritrade
The increase in call IV means that call prices are comparatively expensive. This favors option selling strategies when constructing trades. Selling an out-of-the money bear call spread makes probabilistic sense, especially compared to the risk of shorting the stock outright. The trade will position to profit from a pullback, or at least a consolidation, in an overbought and overvalued NIO stock.
Trade Idea
If you’ve read this far, here’s a trade idea for you: Sell NIO Jan $65 / $70 call spread for 80 cents net credit.
Maximum gain on the trade is $80 per spread with maximum risk of $420 per spread. Return on risk is 19.04%. The short $65 strike price provides a 32% upside cushion to the $49.25 closing price of Nio stock. The spread expires before the next earnings report due in mid February which eliminates any earnings related jump risk.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
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