Nearly a month ago, we took a shot from the short side on ADSK, one of the many cloud/SaaS companies that had been at the center of the volatile price action in momentum stocks in 2014. At the time, we were trying to catch the stock near its highs with the thinking that declines from that point could be a lot sharper than moves to new highs. Here was the original trade and rationale:
TRADE – ADSK ($55.70) Bought Aug 55 / 50 Put Spread for $1.38
-Bought 1 Aug 55 Put for 1.80
-Sold 1 Aug 50 Put at 0.42
Break-Even on Aug Expiration:
Profits: btwn 50 and 53.62 make up to 3.62, max gain of 3.62 at 50 or lower
Losses: btwn 53.62 and 55 lose up to 1.38, with max loss of 1.38 at 55 or higher
Rationale: We view the likelihood of a 5-10% move higher in ADSK as less likely than a 5-10% move lower over the next month, for 3 main reasons. First, the technical situation suggests significant resistance above. Second, the growth stocks in general have been under pressure this week, which could be the start of a Mar/Apr type selloff. Finally, ADSK has rallied more than 20% over the last 3 months, even with an already elevated fundamental valuation. We plan to hold on to this position unless ADSK breaks $57.50 to the upside or $52.50 to the downside.
With the stock now about 53.50 this structure is a winner, trading about 2.10 or so. Looking at possibilities for the structure from here until August expiration, this strikes us as one that we could let run if the market weakness we’re seeing today has some follow-though. Take a look at the 1 year chart:
The selloff that began in February took this stock from a high of 58 to lows of about 45. The break today of the 50 day moving average could lead to another few down days, and this stock could be at its 200 day moving average of 50 in not time. A break of that level and the mid 40’s are a possibility. Right now the structure is about 40 deltas, but that will accelerate towards 100 the closer we get to Aug expiration if the stock is below 55.
So this is the type of thing we’re looking at when analyzing when to take off a structure like this. With only 2 weeks left until it expires it could be worth the max or close to the max, but with earnings a few days after expiration, what it does between now and then is very market dependent. So if the overall weakness continues, this is probably one of the shorts we’re most likely to let run. Of course, if this sell-off is just another head-fake, we’ll be forced to close the position for a smaller winner. But that’s a risk reward we like.