The race for Nike Stock is over

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Shares of Nike (NYSE:NKE) hit new all-time highs last week before pulling back. Nike stock briefly traded above $130 after the latest earnings release and then ran into some serious resistance. Nike looks tired and toppy after hitting overpriced and overbought levels. All of which means it’s time for Nike’s recent scorching rally to cool down.

Admittedly, the results published last Wednesday were impressive both in terms of turnover and results. Earnings per share were 95 cents, well above expectations for only 46 cents. Revenue of $10.59 billion beat estimates by just $9.11 billion. Most of the momentum was due to impressive online sales, which may be difficult to replicate in the future. Nike has released forecasts for revenue growth of around 10% for 2021.

However, the valuation of Nike shares has become very expensive…even after the earnings beat. In fact, its current price-to-earnings (P/E) ratio now stands at over 70x. This is its highest level in the last decade. Meanwhile, its price-to-sales (P/S) ratio just surpassed 5x. It is also at a 10-year high. Both metrics are double the 5-year average of Nike shares.

Nike is really rich even in the front. The analyst consensus is for a profit of $2.45 for fiscal 2021. This would put the forward P/E at 50.51x. It’s hard to imagine that Nike could continue to grow profits and revenues at rates that would justify such levels of valuation. Consider that 10% sales growth simply does not equate to a price-to-sales ratio multiplied by 5.

A Closer Look at Nike Stock

Nike shares have been extremely overbought from a technical standpoint. Its 9-day RSI crossed the 75 zone before weakening. Momentum also reached a recent extreme before running out of gas. Its Bollinger Percent B exploded higher as it surged past 100 and the highest readings of the past year. The stock is also trading at the largest premium to the 20-day moving average, which has led to pullbacks in the past.

Source: TD Ameritrade Thinkorswim® Platform

More importantly, Nike had a major reversal day after the earnings release. The shares opened at the day’s highs above $130 before quickly reversing to close just past the day’s lows. This type of price action is often a sign of a major short-term top in the stock. Buyers are eventually exhausted and sellers are in control. It is all the more powerful for having taken place at historic heights.

Nike stock is poised for a pullback on both a fundamental and technical basis. Shorting Nike can be risky and requires a large margin of error considering the price of NKE shares. The options market, however, offers lower risk and a cheaper way to take a bearish position in the stock. A bearish out-of-the-money call spread positions you as a seller above all-time highs, while collecting premiums now.

How to Trade Nike Stock

Buy to open the November $140 NKE calls and sell to open the November $135 NKE calls for a net credit of 1.10.

The maximum gain on the trade is $110 per spread. The maximum risk is $390 per spread. The return on risk is 28.2%. The short strike of $135 provides an upside cushion of 8.6% to the closing price of $124.32 for Nike stock. It is also well above all-time intraday highs at $130.38. The margin requirement on the trade is $500 per spread minus the premium received of $110 per spread or $390 per spread.

As of the date of publication, Tim Biggam had (neither directly nor indirectly) any position in any of the securities mentioned in this article.

Anyone interested in learning more about options-based strategies or receiving a weekly newsletter on options and volatility can visit the Options and Volatility Newsletter website.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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