Trade Alert: Betting On A Pullback In A Parabolic Stock

This money-losing communications equipment company is up nearly 500% since its last earnings miss.

Animal Spirits Out Of Control

This company has come up on my bearish screens before, but its stock has gone parabolic in the last few weeks, so much so that it gets an overall technical rating of 9 (out of 10) from our friends at Chartmill. Ordinarily, I wouldn’t bet against a stock with such a high technical score, but in this case, that technical rating is tempered by a setup rating of 1 (also out of 10), indicating that prices are likely to pull back in the near future.

That’s what we’re betting on here, but since there isn’t much difference in price in betting against the stock to drop in the near term and over the next several months, we’re giving ourselves a longer time horizon for this to play out, if necessary. Given that the stock is up nearly 500% since its last earnings release, when it missed on both the top and bottom lines, and the news since doesn’t justify the current move, it seems likely this stock will start to trade more inline with its fundamentals at some point this year, and those fundamentals are not good. Chartmill gives it an overall fundamental rating of 2, with profitability, health, and valuation ratings of 1.

Details below.

The company is Applied Optoelectronics (AAOI 0.00%↑) and our trade is a vertical spread expiring on December 15th buying the $10 strike puts and selling the $7.50 strike puts for a net debit of $1.15. The max gain on 3 contracts is $405, the max loss is $345, and the break even is with AAOI trading at $8.85.

If you want a drill-down on the company’s current fundamentals and prospects, this is a good one, by one of the better authors at Seeking Alpha.

Exiting This Trade

For this trade, I’m opening a Good ‘till Canceled limit order to close it at a net credit of about 90% of the spread (the difference between the strike prices of the two legs). Since that spread is $2.50 in this case ($10 - $7.50), and 90% of $2.50 is $2.25, that’s where I’ll be placing my limit order to exit it. If that order doesn’t get filled over the next few weeks, I’ll lower the limit price as necessary as we get closer to expiration.