Solar City has traded down double digits after each of its three earnings reports:
3/6/2013 -14.4%
5/13/2013 -12.4%
8/7/2013 -10.8%
So of course this will happen a fourth time in a row, right? Well, not so fast.
The first post-earnings decline simply reversed a pre-earnings run-up. The stock continued upward from there. The second post-earnings decline reversed about half of a 24% one-day pre-earnings surge. The last post-earnings decline was finally different. It set a one-month low and touched off an additional one-month sell-off. SCTY has more than doubled since then and has even issued a lot more shares for sale along the way.
Source: FreeStockCharts.com
Now, three days ahead of earnings, the stock is once again experiencing a run-up. It is starting to look like a repeat of the first two earnings reports. What prevents me from calling a repeat is seeing the massive run-up of short interest in the past two months. Shorts have been fighting SCTY’s rally the entire way. Shares short are now a whopping 34% of SCTY’s float.
Source: Schaeffer’s Investment Research
What probably keeps the shorts alive and swinging is a lot of hedging. As shares short have soared, the open interest put/call ratio has plunged. The ratio is at 0.82 and has been a lot lower in the past, but the current run-up looks like hedging. (Notice carefully how the put/call ratio soared when SCTY rallied in May. The interpretations of changes in put/call ratios will always depend on the context). These hedges likely mean shorts are NOT going to cover anytime soon and are digging in their heels for the long haul.
Source: Schaeffer’s Investment Research
Finally, analysts are pretty sour on SCTY. Of the six analysts tracked by Schaeffer’s only two are positive with strong buys. The other four are all neutral. This overall bearishness tilts overall sentiment toward the negative against SCTY.
So, from a technical perspective, I do not expect SCTY to trade down much post-earnings, if at all. I also do not expect a massive pop because of the large number of call options traded on SCTY. A substantial portion of the November calls are clustered right around the $60 strike. With the volatility index soaring over 50% in the past month in preparation for earnings, this seems like a time for selling options.
Selling options of course creates more risk exposure than buying (in most cases). So, a selling strategy should probably include an absolute cap on losses. For example, like selling the Nov 16th $60 monthly put for $4.30 and buying the $52.50 weekly put for $0.90. If you want to directly bet contrarian to the massive number of calls accumulated in open interest, then a similar setup for calls makes sense. My preference is on the put side especially given the resilience the stock has shown in the face of pullbacks. Moreover, if I am wrong about a big move, I think I will be wrong to the upside.
Regardless of the type of bet you might decide to place, note well that risks must be very carefully managed. SCTY is volatile, speculative, valued at a premium (like a 23.6 price-to-book ratio!), faces extremes in bearish sentiment, and is in an industry that has experienced severe booms and busts. Plan accordingly!
Be careful out there!
Full disclosure: no position