With the market hitting record highs recently, stocks that have been bid up beyond their historical valuations are at risk of a pullback. The industrial sector, for example, has rallied more than 22% since the November lows — with General Electric leading the pack at a more than 40% gain in that period. GE is now above $150, prices that we haven’t seen since 2017. It’s also trading at the highest end of its historical valuation. In my opinion, this rally in GE is overdone and an opportunity to fade the strength. Looking at a 20-year chart of GE, you’ll see it’s rallied around 200% over the past 18 months and breached a major bearish trendline that started in 2007-2008. This marks a potential stopping point for this rally. Additionally, all momentum indicators have reached severely overbought conditions that statistically point to a potential pullback in the short run. While the charts provide us with a thesis that the timing is prime for a pullback, the most glaring issue is the fundamentals. GE now trades at 32x forward earnings, which is the highest it’s ever traded for over the past 10 years by nearly 20%. GE is trading at the same price as in 2016, when it was earning nearly three times more in profits. Analysts are forecasting that GE will return its 2016 EPS of $8.24 sometime in 2027. I feel that investors are being overly optimistic on GE’s prospects at the moment by assigning such a ridiculous valuation. Surprisingly, despite trading around seven-year highs, GE’s implied volatility is quite expensive. This provides an environment that favors selling options and fading this move. It also aligns with a neutral/bearish outlook on GE based on the technical and fundamental factors. The trade structure that I prefer to use here is to sell options and collect premium while taking a neutral/bearish outlook. Selling a Call Vertical Spread is the structure that I would use for this GE trade. I’m selling the March 28 $150/$157.50 Call Vertical @ $2.80 Credit. This involves: Sell March 28 $150 Call @ $4.57 Credit Buy March 28 $157.5 Call @ $1.77 Debit This will profit $280 per contract if GE stays below $150 at expiration, while risking $470 per contract if GE were to trade above $157.50 at expiration. DISCLOSURES: THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
