How to Short a “Story Stock” for Quick Profits
A few days ago, I closed out a short put position in 3D software designer Autodesk (NSDQ: ADSK) for a nifty 49% profit in just seven days in one of my trading services. Anytime you can turn a huge profit on a trade that fast there has to be some luck involved, but in this case I also knew that the odds were in my favor.
Below I’ll explain why, and how you can book similar gains by following my example.
Autodesk is what’s known as a “story stock,” a company that’s hyped beyond the capabilities of its fundamentals. Over the past two years, ADSK has more than doubled in value making it one of the trendiest names to own. How trendy? About 99% of its outstanding stock is held by institutional investors, the so-called “smart money” on Wall Street.
But there are ways to beat the smart money at its own game.
A closer look at Autodesk’s trading history reveals an interesting, and potentially lucrative, pattern. Each year during the second quarter the stock has taken a hit before recovering during the second half of the year.
In May 2016, Autodesk opened the month at $60 and closed near $58 for a modest 4% loss. Last June, it more than doubled that decline, shedding 10% of its value. In both cases, the stock rose on the strength of annual guidance provided with the release of year-end results, but then gave back some of that gain when the first quarter results for the following year did not live up to expectations.
So this year, I was lying in wait for Autodesk to repeat that pattern. True to form, it raced up nearly 40% during the first quarter of 2018 while the rest of the stock market was struggling to break even. Half of that gain occurred during one week in March, after the company released its fourth-quarter results for 2017 and guidance for this year.
However, I noticed that the company snuck in this seemingly innocuous statement at the end of that report:
“Starting with the first quarter of fiscal 2019, Autodesk is adopting the new revenue accounting standard, ASC 606.
- We will be applying the modified retrospective transition method.
- We do not believe the new standard will result in a change in timing or amount of the recognition of revenue for the majority of our product subscription offerings and enterprise agreements.
- We will be required to capitalize and amortize sales commissions under the new standard.
- We do not expect a significant impact on reported expenses for the full fiscal year, however, the timing of when we recognize the deferred commissions by quarter will vary compared to our historical seasonality.
- None of the ASC 606 impacts affect cash flow.”
If I’ve learned anything over 30+ years of investing, it’s that when a company adopts a new accounting standard, you can be assured that it won’t be good news for shareholders. Also, when they say it won’t affect revenue or cash flow but don’t mention earnings, you can bet there is a good reason that profitability is being ignored.
That’s when I put a reminder on my calendar to check back on Autodesk in May, prior to the release of its first-quarter results.
Pulling the Trigger
Two weeks ago, I was relieved to see that Autodesk had not yet gone through its annual swan dive just before the release of its first-quarter results. I was even more excited to note that the stock earned the lowest possible score of zero from my IDEAL Stock Rating System (on a scale of 0 – 10) and that its RSI (relative strength index) score was peaking above 60 (on a scale of 0 – 100), suggesting it was close to fully valued and poised to take a dive.
So last week I pulled the trigger, recommending to readers of my Systematic Wealth trading service that they buy a put option on Autodesk with a strike price of $137 expiring on June 1. I was suspicious of the fact that the company was waiting until the Thursday evening before Memorial Day weekend to release its results, reasoning that only bad news would be relegated to one of the slowest trading days on Wall Street.
Sure enough, last Thursday evening Autodesk reduced its profit guidance for the remainder of the year, driving its share price down 5% the following day. At the start of this week, it dropped another 3% at which time I closed out my option position.
Had I simply shorted the stock I would have realized a nifty 8% gain, but by using a put option I magnified that gain more than six times in value. I also limited my risk to the cost of purchasing the option, unlike shorting a stock which has unlimited risk.
Autodesk is not the only stock that has a pronounced trading pattern throughout the year. Although those price movements are sometimes fairly small, by using options you can generate massive gains in a short period of time.
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