Virgin Galactic (NYSE:SPCE) shares look attractive after this week’s retreat. The fact that the descent came in part due to a double downgrade from Bank of America Securities shouldn’t deter would-be SPCE stock buyers one bit.
After last week’s parabolic rise, profit-taking was desperately needed to return SPCE stock to a more palatable level for new entries.
Besides, given the enormous gain in such a short period of time, the downgrade to “underperform” was more than justified. What do you expect a fundamental analyst to do when the share price balloons from $14 to $57 without any accompanying rise in earnings? The valuation levels became too stretched for Bank of America to maintain their “buy” rating.
But just because I see the logic of an analyst’s downgrade doesn’t mean I don’t like buying the dip in some fashion. So let’s dig deeper into the price chart to explain why I’m probably not the only spectator interested in playing here.
The Big Picture
For a bird’s eye view of Virgin Galactic’s history, let’s start with a weekly time frame. Here are the three things that stand out to me.
First, SPCE stock is insanely volatile, which is a fact that cuts both ways. When you’re on the right side of the momentum, swift profits ensue. But watch out when the tide turns! An equally quick swoon has followed every surge. This fact, above all others, is why I’m going to suggest a short premium cash flow play below. It will allow plenty of room for the price to whip around while still yielding a profit.
Second, the volume that accompanied the six-week upswing that just ended signals big buyers entering the fray. This makes me more tempted to buy the dip than if volume remained subdued during the ascent.
Three, despite the messiness of Virgin’s price chart, the overall trend has been trekking higher, as confirmed by the rising 50-week moving average. This gives the stock a slightly better posture than what it had early last year.
With the big picture in mind, let’s move into the daily view.
SPCE Stock Daily Chart
Not all dips are created equal. Some are preceded by an uptrend that is slowing in momentum and showing signs of distribution. I avoid those. Others transpire after a powerful surge. Given the strength behind the previous advance, I’m always interested in these types. SPCE stock is offering one such setup.
On June 25, after news struck that the company finally got approved to transport passengers into space, buyers jammed SPCE to the moon. In a single session, the stock climbed 42%. What’s more, the gains came after prices had already more than doubled off the lows in the preceding month. Given the extremely overbought conditions, it’s not surprising that we finally saw traders ring the register.
But with the 20-day moving average rising quickly beneath and a potential gap fill looming if prices retreat further to $40, I think the dip will get bought.
Short Puts to Play
The silver lining of Virgin’s otherworldly volatility is that options premiums are fat – really fat. The implied volatility trades near 140%, roughly nine times higher than the S&P 500‘s. As a result, we can build a trade that profits if SPCE stock doesn’t simply implode from here.
For instance, if you’re willing to wager prices don’t fall below $20 by August expiration, then you can sell the August $20 put for 45 cents.
The initial margin required is only around $100, making the potential return on investment north of 40%. If you don’t like the open-ended risk of a short put, then bull put spreads also work. I suggest selling the August $25/$20 spread for 60 cents credit.
On the date of publication, Tyler Craig held LONG positions in SPCE. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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