How I Trade a Bearish Stock on the Cheap

Hey there, Power Profit Traders!

Unfortunately, I have some bad news…

I’m under the weather and won’t be doing much of anything this week.

However, that doesn’t mean I won’t be dropping some key trading lessons in your daily Power Profit Trades newsletter, and today you can still catch my resident options expert trading and teaching LIVE from 9:30-10:30 a.m. ET right here. (And don’t forget, you can now watch REPLAYS of my sessions right here!)

And just because I’M not having much fun this week doesn’t mean YOU shouldn’t soak up the holiday cheer!

So I have to INSIST you attend our first ever Mistletoe Mania event at 7 p.m. ET tomorrow, Dec. 21! Trust me, it’s gonna be a PARTY (perhaps with a few special gifts in your stocking… but I’ve already said too much).

That said, today I want to walk you through one strategy I use a lot to trade a bearish stock on the cheap.

Technology stocks attract many investors on the promise of higher growth. This means that stock traders are often willing to pay up to own shares of tech companies that are expected to deliver higher-than-average earnings vs. the general stock market.

And this shows up in comparing the current price-to-earnings (P/E) ratios for the S&P Information Technology and general S&P 500 Index (SPX).

 

 

SPX & S&P Information Technology Index P/E Ratios – Source: Bloomberg

 

 

The technology stocks show a P/E of nearly 34 times trailing earnings – that is way more expensive than the P/E of the S&P 500 Index, at 25 times trailing earnings.

What does this mean?

The market expects tech stocks to out-grow the general market – and they’re willing to pay up to get that outperformance.

But when a tech company tells the market that it expects to grow less – Katy, bar the door, as they say; the market will punish that stock, pure and simple.

Late last week, that’s exactly what happened with a well-known tech name, in response to the firm’s earnings and sales expectations for 2022.

I immediately went to work to set up a bearish trade on this stock… read on to learn how I did it on the cheap, and how my trade is setting up.

When Guidance Guides the Stock Lower

The company I’m referring to is Adobe Inc. (ADBE). This is a big company with products that are used, at least in part, by nearly everyone – from individuals to major corporations.

Adobe makes and offers products and services that enable processing, sharing, and publishing documents, images, videos, and other items, offering storage and access via cloud-based services.

It has been a big beneficiary of virus-fueled remote work – but its revenue growth, after peaking at the start of this year, has been trailing lower quarter after quarter.

And for its just-filed quarterly report, Adobe’s revenue growth fell even more.

But what really did ADBE stock in was the company’s guidance for next year, stating it wouldn’t meet or exceed revenue estimates for 2022.

 

 

 

Adobe intraday price last week – Source: Bloomberg

The stock was already trading lower into the quarterly report, and the sell-off didn’t wanna stop.

And in turn, I got quickly involved to find the right bearish trade for Adobe for my Operation Surge Strike subscribers on Friday.

For an option trade, the obvious bearish bet might be just buying a put option. (In fact, I closed a winning put position in my Rocket Wealth Initiative late last week.)

But with volatility up for the general market, options on tech stocks – and for Adobe, in particular – were pretty expensive, as volatility is one of the major drivers for option pricing.

Instead of buying more puts, I worked up a less expensive trade: a Bear Call Spread on Adobe.

This strategy entails selling to open a call to bet on a chart ceiling for the underlying shares, and simultaneously lowering the cost of entry – and maximum risk – by buying a higher-strike call in the same options series.

The result of the pair is a net credit, which represents the maximum reward on the trade, should the underlying shares stay beneath both call strikes through expiration.

 

 

 

ADBE Stock – Source: TomsOptionTools.com

The lesson to learn is that in the options market, there is always more than one way to trade your outlook for a stock.

If option prices are running hotter than usual – and on the Expensive IV list from the Morning Report tool, say – you could always consider a credit spread over buying directional options outright.

So, kids, that’s your Power Profit Trades lesson for today! Be sure to tune into this morning’s Power Profit Trades session at 9:30 a.m. ET right here! I won’t be there, but Joe – an options expert from my team – will be doling out the lessons you don’t wanna miss.

And then make sure to save the date for tomorrow night’s Mistletoe Mania event – it all starts at 7 p.m. ET on Tuesday, Dec. 21!

Have a great week!


Tom Gentile
America’s #1 Pattern Trader

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