After three days of big gains in the market, Thursday was about one thing: Not losing anything. As I’ve noted, S&P 500 momentum has remained positive after bottoming out last week. But the rest of the market (the more than 8,000 stocks traded publicly) are still in the red. This creates a unique opportunity for a turnaround trade.
We have more than 65% of stocks trading under their 50-day moving average, and about 58% of stocks remain under their 200-day moving average. Small-cap, micro-cap, and nano-cap stocks are still under heavy pressure. The Russell 2000 gave up prior gains and remains locked in a negative channel.
Now, we eye these stocks because this is where there’s more speculative capital. The mega- and large-cap stocks continue to see large institutional flows, but for the most part, this was a very boring trading day. That doesn’t mean opportunity doesn’t abound right now. Let’s look at one.
Kirkland’s Looks Like A Trade
Right now, home prices continue to surge and price out many would-be buyers. What does that typically mean? To be short: Americans tend to focus on improving their existing homes. It’s one of the reasons why Home Depot (NYSE:HD), the home improvement giant, has become a conviction Buy among so many financial institutions.
But home decor has lagged. And Kirkland’s (NASDAQ:KIRK), a stock with an average price target on Wall Street at about $30, is trading at roughly half that level. The stock has taken an absolute bath and plunged over the last few weeks. The relative strength index over 14 days sits under 25, and its 30-day RSI is still well under 35. These figures tell me that the stock is extremely oversold.
The reality is that a lot of investors are not patient enough to wait at least another quarter for the stock to improve. This is effectively capitulation. But the balance sheet remains very strong. And it’s right in the middle of a turnaround trade story. In the wake of this massive selloff, investors have a chance to speculate a little bit and buy the stock, or trade options as a way to go long.
Getting Into the Numbers
Going out to July, traders could do something called a vertical spread. In this situation, they would purchase the $15.00 July 15, 2022 call for $3.00 or better and sell the $22.50 call for $1.15 or better.
This creates a net debit of $1.85, meaning that you would need to spend $185 for every contract that you want to purchase. In this event, you would need the stock to reach the strike price of $15 plus the $1.85 premium ($16.85 total) by the expiration date. Going out two quarters it creates a nice opportunity and sets your total risk at $185 total.
Since this is a spread, you would cap your total gains at the total of the strike price on the contract you sold plus the premium. In that case, you would stop generating a profit if the stock price climbed to $23.65.
So, the maximum that you can earn on this turnaround trade is ($23.65 minus $16.85). That is a total of $4.80 or roughly a 190% gain. Combining the F-score (over 8) to show a strong balance sheet plus a longer-term selloff (oversold) can create unique risk-reward trades.