Though it may feel wrong to market participants that are new to trading markets for corporate executives with knowledge of the inner workings of a company to be able to buy and sell shares in their own company when done by the book this practice is completely legal and represents one of the pillars of capitalism.
As traders, it is our job to always be on the lookout for market phenomena that don’t extend beyond the norm, as such events often present opportunities for profit.
According to Investopedia, “Insiders at public companies essentially have two options for buying and selling their companies’ stock. The first is to conduct the transactions in the open market whereby they buy or sell securities through a broker just like any other retail investor.
The second option is to conduct the transaction on a systematic basis through what is called a 10b5-1 plan. This Securities and Exchange Commission (SEC) rule permits a systematic form of insider trading that is legal. However, the trading activity allowed via 10b5-1 can be beneficial for both insiders and individual investors.” Click here to learn more.
Today, we’re going to look at one company where insider selling has been extreme of late, at a time when the deterioration in bullish trend mechanics may be presenting an opportunity for a bearish trade.
Insider selling by the father of Cavana’s CEO is suspect
Like shares in many companies since the trough of the COVID-19 crisis in early 2020, shares of Carvana (CVNA) have undergone incredible appreciation.
Specifically, from its March 2020 low to its August 2021 high, the stock gained as much as 1160%.
Since the 3rd quarter of 2020, however, there has been a sharp increase in the trend of insider selling, with no insider buying to speak of.
Let me be clear, all sales have been executed through legal channels. It’s just that the sharp rise in the amount of selling is a red flag.
Aside from Jeff Bezos, Mark Zuckerberg, and members of Walmart Inc.’s Walton family, no individual has earned more from selling stock in their company over the past year than Ernest Garcia II, a 64-year-old billionaire, and father of CVNA CEO & Founder Ernest Garcia III.
Ernest Garcia II has sold $3.6 billion worth of stock since October, amounting to 16% of his holdings in the company.
This can be seen on Figure 1 below.
Carvana has already admitted that could be a red flag for some investors.
A securities filing reveals that Carvana’s own filings warn against the “Garcia parties” not being “aligned” with investor interests.
Academics and regulatory types have echoed those concerns, claiming that revisions to the company’s “stock selling plan” (10b5-1 plan) have been changed frequently.
The same parties are concerned that the family owns 85% of the company’s voting shares, in total.
While there is nothing illegal about the structure, the massive increase in insider selling activity is suspect enough for a savvy trader to take a deeper look at the price action to find out the real story.
I always look to price to confirm my evidence
Never forget, price is the ultimate arbiter when it comes to whatever evidence you think you are seeing in your analysis.
The current price is a reflection of what thousands of shareholders, some of them very sophisticated, know about the company.
So when we look at a chart, everything we need to know about the perceived valuation of the company is right in front of us.
When we look at the chart of CVNA, we see a stock that is, at first glance, in the midst of a long-term uptrend.
If we take out some trusted tools from our technical toolbox and apply them to the chart, however, we see what might be the makings of a weakening uptrend.
Specifically, when an uptrend is in the process of rolling over, one of the first places the evidence shows up is in the slope of some of the intermediate-term moving averages, such as the widely followed 50-day moving average.
And when the slope of that moving average starts to turn down and act as resistance, at a time when the RSI momentum indicator has failed to push above 60 during a recent rally, it is often a signal that the longer-term trend is transitioning from up to, at a minimum, sideways.
These developments are made apparent on Figure 1.
Remember, we can’t predict the future of price action, we can only speculate on it.
Therefore, if we control our emotions when we see exciting evidence such as this deterioration, the safest way to play it is with expectations that shares of CVNA are more likely to remain weak or range-bound for a while, rather than betting on an aggressive decline.
If the chart had been showing some sort of a bearish pattern such as a “bear flag,” then that would be a different story.
But for right now, without the presence of an obvious bearish pattern, we have to create a trading plan that takes that into account.
That’s where certain options strategies give us an upper hand, to be able to profit from the simple passage of time in situations when the technicals are not providing any clear indications that price is poised aggressively in one direction to fight the effects of time in a range-bound market.
I like to consider selling a bear call spread on CVNA
At RagingBull, we’re all about finding the chart setups with favorable profit potential and minimum risk.
When it comes to risk management, perhaps no options strategy is better suited than the vertical credit spread.
Let’s walk through the particulars of how we would want to go about placing a vertical credit spread known as a “bear call spread” for CVNA in the coming days.
When it comes to learning multi-leg options strategies, vertical credit spreads are among the easiest and are therefore a great place to start.
Why are they relatively easy to comprehend?
Because they include either selling one put and buying one put (bull put spread) or selling one call and buying one call (bear call spread), and only include options of the same expiration month.
The maximum gain that can be earned from a credit spread is the net credit, realized when both options expire out of the money.
The maximum loss potential is the difference in strike prices – net credit. Realized when both options expire in the money.
In the case of CVNA, the trade setup would be as follows:
- Identify the trade bias (we’ve identified a bearish setup)
- Identify where the stop-out level is (let’s call this the anchor point).
- Identify the strike levels that will allow you to enter the trade with what would ideally be no worse than a risking 4 to make 1 setup. There is some leeway here, but generally, you should try not to risk more than 4 to make 1.
Let’s break each bullet down a bit further.
For bullet 1, the highest probability trades usually occur when a trader is trading with the trend, not against it.
In this case, we’re using the lower slope of the 50-day exponential moving average as our indication that the intermediate-term trend is now lower.
For bullet 2, we’ve identified that the 09/16 pivot high is the level that must hold as resistance if the newly bearish intermediate-term trend characteristics are going to remain in effect.
Therefore, the 09/16 pivot high of $345.98 is the ideal stop level (i.e., the anchor point).
When it comes to bullet 3, this is where we must start exercising patience.
I’m constantly preaching how important it is not to chase trades and to let the trade come to you.
When it comes to this CVNA trade idea, the trader’s ideal spread entry would be for him or her to be able to sell a call option that anchors as close to the $345.98 pivot high as possible and buy a call option with a strike that is roughly $10 to $20 above that area.