As a general rule of thumb, speculators enjoy a greater potential to profit from the downfall of a publicly traded enterprise than on the upside. Although shorting is a controversial tactic, it can benefit from the intense, emotional reactions associated with extreme pessimism. In an avalanche of red ink, people are worried about salvaging their wealth, not about scoring a few points in a pickup match.
With greater stakes involved, it’s no wonder why certain traders look for bearish opportunities, so to speak. However, finding such ideas can be a challenge. A key risk associated with the short side of the spectrum is that the market tends to have an upward bias. Further, the popularized concept of the short squeeze has made becoming a professional bear a rather dangerous occupation.
Still, for those who do want to live life on the edge, Barchart Screeners offers an intriguing addition: End of the Road. As the trading analytics resource puts it, “One of the most telling signs of a trend reversal is the ‘End of the Road’ gap. This downside gap typically occurs after an exponentially expansive rally, signaling an abrupt end to the uptrend.”
Only two companies popped onto the radar on Thursday, one of them being PureCycle Technologies (PCT). Operating in the pollution and treatment controls segment of the industrials sector, PureCycle holds a global license to commercialize the only patented solvent-based purification recycling technology, per its public profile.
It sounds like an interesting business on paper. However, the company is currently a pre-revenue enterprise. To be fair, analysts anticipate sales of $22.48 million by the end of this fiscal year and revenue of $133.75 million by the next. Still, investors may be impatient with PCT stock, possibly setting up a cynical trading prospect.
Examining the Technical Case Against PCT Stock
For full disclosure, this is the first time I’ve ever heard of the End of the Road gap. Nevertheless, it appears that Barchart’s algorithm initially identified the signal on Sept. 25. Prior to this session, PCT stock had been skyrocketing. On Sept. 10, shares traded hands at less than $5 a pop. Two weeks later, the price closed at over $10.
However, subsequent progress has been slow since then. On Wednesday, PCT stock incurred a bout of red ink during the early morning hours, eventually closing at $9.14. Yesterday, shares dipped again to $9.09. Over the next few sessions, there could be some back and forth between the bulls and bears. However, the pressing fear is that PureCycle will suddenly drop.
If so, where might PCT stock land? The closest obvious target is the $8 level, which represents weak support. In late July of this year, PureCycle shares managed to reach this zone before stumbling. Should bearish pressure break below this line, the next downside target rests at $6. This is where a much stronger level of support exists.
One date to keep in mind is Nov. 14. That’s when PureCycle may release its third-quarter earnings report. Should that report disappoint — let’s say that revenue projections get pushed back — it’s quite possible that PCT stock could correct sharply.
Depending on our position, the drop could be quite lucrative.
A Risk-Controlled Mechanism to Short PureCycle
Given that PureCycle is a small-capitalization firm with a modest share price, it’s not sensible to directly short PCT stock. Plus, a 60-month beta of 1.63 means that shares are quite volatile, adding a layer of unpredictability to an already difficult situation. If you must speculate against PCT, it’s better to go with a bear put spread.
Representing a specific type of vertical option spread, a bear put spread already has risk control baked into the framework. By buying and selling a put with the same expiration date, we can make the net debit paid to enter the position cheaper. As well, this cheapening also serves to narrow the threshold to profitability, making the put spread an attractive proposition for short-term speculation.
Now, there are many ideas to consider. However, if you believe that a quick drop is imminent, then you may consider the 10/8 put spread that expires on Nov. 15. The details are as follows:
- Buy the $10 put (at $1.95 at time of writing).
- Sell the $8 put (at 70 cents).
- The net debit paid of $1.25 represents the most that we can lose in this trade.
- The maximum profit (should PCT stock fall to or below $8 at expiration) comes out to 75 cents.
- Breakeven lands at $8.75.
There are more aggressive spreads in this expiration chain, including the 9/7 spread and the longshot gamble 7/6 spread. For these trades to be profitable, PCT stock must fall to or below the lower strike price.
Ultimately, it’s a high-risk gamble. However, if you believe in the power of the downside gap signal, PureCycle is the name to watch.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
