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SolarCity: Dark Clouds Loom, Creating an Opening for the Bears


Bear call spreads could be the way to go with SolarCity.

I was recently exchanging stock ideas with T3 Live CEO Evan Lazarus. 

One that really stood out for me was his bearish call on SolarCity (SCTY). This is a stock that has looked overpriced within a solar industry that's been under pressure. Oil and gas prices are cheap. Incentives and tax breaks are harder to come by and the leasing model that SolarCity uses makes assumptions that just may not work out. 

Overall, I agree with Evan that this is a great target for the bears.

Most of you would trade this by simply shorting stock, but I wanted to show you a different approach using options.

I would build the trade using the options expiring February 20.

We are shorting the $55 strike call and reducing our risk by going long on the 57 strike call.:
  • Sell SCTY 55  2/20/2015 Calls @ $0.66
  • Buy SCTY 57 2/20/2015 Calls @ $0.35
This nets us a credit of roughly $0.31 on a margin of $1.69

By selling a short call option against a long call option, I am creating a bear call spread.

As long as SCTY is below $55 on February 20, we will profit $0.31 ($31) per lot.  It is currently trading at $48.

Our margin and max risk is $169 per position, giving us an ~18% return on the trade if we win. The best part is that based on the market probabilities, we have roughly an 80% chance of being successful in this trade. Remember, SCTY doesn't necessarily have to go down for us to win -- it only needs to stay below $55..

If SCTY shoots up above $55 quickly, we risk the margin on the position $1.69 ($169) per lot. Losses can pile up fast in that scenario, so consider your risks when sizing your trades. Normally, I would put a stop loss alert on this at a roughly 30% loss. This allows me to limit my risks.

Good luck and good trading,

Doug Robertson

Co-Editor, OptionSmith

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