happy friday and welcome to "options action" i'm melissa lee live from the nasdaq site over looking new york city's time square we have a big store on tap, here's the lineup. >> which adobe is? a solid earnings going into the week or mud brick, carl will model it out for us, maybe even in clay. and tony zhang continues to rain on cloud computing plays which name he thinks won't strike twice. and plus now we have your attention,

professor khouw busts outlandish myths about naked shorts and meme stocks. time to risk less and make more. "options action" starts now >> adobe is out with earnings next week and like its name sake mud bricks the chartmaster thinks this name is solid and strong, carter, what do you see? >> i do. it's timely. one of the things about timing is, you can get the direction wrong but playing for a break out in response to earnings. several charts the first is a two-panel what you see of course is that adobe just this week has returned to where it was almost a year ago late august, early september and the principle of a break out is after some backing and filling you typically can exceed a prior high equally important and absolute relative is the bottom panel, relative performance to s&p 500, while adobe is going sideways the eight to tevn months it is

under performing but c just starting outperformance to the s&p. very important several ways to draw the line. absolute adobe chart first, you can call it an ascending triangle or wedge, doesn't matter what you call it. the next one, this is a big sort of rounding bottom in the context of the sideways action of the past 10 months. the next one, cup in handle. again call it what you want. these formations over time, throughout history have been reliable more often than not next one is head and shoulders bottom of sorts in this consolidation pattern and the final one putting couple together. essentially a key moment, at a

key former high. now make your bets we think it will break out and exceed the former high. >> all right mike, what is the trade for adobe? >> yeah so adobe we obviously have the stock trading at all-time highs right here right now. that might make it a tough reach to go out and buy the shares with earnings coming up we see that familiar regime of higher short-term implied volatilities, relative to the longer term implied vol, we want to take voj of that. this company not cheap, trading 42 times forward earnings, below the five-year average of 44 times. one of the reasons, we have 20% top line growth. and there's a lot of good tailwinds for the company right now. creative cloud obviously one of the things we're seeing really helping to propel their business and the small and mid-size business recovery that we're really expecting here should also provide a bit of a tailwind one way to make a i bullish bet is to buy a longer dated september 5.40 call trading for

over $20 earlier today and look to sell some of the elevated short dated premium looking at june 5.55 calls just under $5, net net would lay out $23.75 per share. that's about or just under 4.5% of the current stock price to make a bullish bet quick point. we often use diagonals the idea to sell the shorter dated premium but also insure you can't be wrong if the stock over shoots your upside target. here that's not the case because we're laying $23 and the distance between the strikes $15. that said the stock will really have to make a strong move by the end of the next week for this to be a loser to the upside so wee trying to take advantage of that implied volatility dynamic and owner stock and lay out less premium than buying high volatility shares outright. >> tony what is your take on the

trade. >> i quite like this because you have a very clear break out after long consolidation period and most importantly the relative factor, showed adobe relative to the market, it's also breaking out relative to technology, it's sector, that's extremely constructive heading into earnings. mike referred to the top line growth, 20%, from my perspective, 40% profit margins and 90% come from subscriptions and they're a clear leader in their space leads me to believe they will have another strong quarter. and it's a great advantage to take advantage of selling short dated higher implied volatility option and buying lowerier implied volatility options the risk is if you get a significant upshoot of this particular stock you could under

perform but he's only risking 4 .5% of the stock's value to take this trade. great way to play upside on a stock trading all-time highs. >> mike, last word on this trade. >> yeah, the critical thing here, this is a fairly familiar phenomenon, we obviously have a long bull market, a lot of stocks trading essentially at their all-time highs, not necessarily their all-time peak multiples, which speaks to the operating strengths of these companies, adobe is a good example. two things to pay attention to, obviously market capitalization, top valuation, but also how does it compare to the historical valuation for these businesses some of these companies, high as they are, are actually trading at lower multiples than the last two to five years. >> sticking with tech, cloud security company okta had a nice run this week but tony thinks there's too much fog in the forecast, tony, what do you see? >> that's exactly right. while security is at the top of

mind for a lot of investor i think on this particular cloud security stock there's potential down side here we look at the chart itself, the stock is trading at a very wide range between 210 257bd -- and 290. it did have strength this week, i think it's the opportunity to look for short exposure as it tests the 210 support level. the reason i think it could break that major support level because if you look at the stock relative to the sector slk it's already broken those support levels, that's a suggestion we could see some further declines. if you look at the business itself, it's basically almost the exact opposite of what we're seeing with adobe, yes, top line growth is decent 20 to 25% year-over-year but eps is down 82% over that same amount of time especially with a stock trading at extremely rich valuations of 30 times sales and quarter over

quarter revenue growth slowed to single digits that's a recipe that will be hard for the stocks to sustain this valuation. so the trade structure i'm using reflects what i see as potential, sizable down side if it does break below the $210 support level is to take advantage of the fact implied volatility here is extremely cheap,actually at its lowest we've seen in the past year by going to august buying the 220/190 put spread i'm paying $11.90 to pay for the august 220 out of the money put and i'm selling the august 190 puts against it collecting $3.30 paying net net $8.60 for this put vertical which is less than 4% of the stock's price. and the reason for this is really just because we are going into a strong market, taking a bearish position is not particularly favorable for a lot of investors so try to keep the

risk as low as possible is the way i want to play this, low probability, high potential reward >> mike, what's your take? >> yeah, i mean, one of the things we often look for when looking at put spreads we try to take advantage of term structure, where we try to find the cheapest implied volatility, sell the most expensive. that also when looking at out of the money options and out of the money puts, trading at higher volatilities gets the math working for you and with put spreads we look for 3 to 1 pay off but this doesn't achieve that but it's justified because in the last month this stock traded $290 so to get to the 190 strike call it 225 wherever the stock closed today, not a big move given how much the stock has demonstrated it can month of good way to make a bearish play here. >> carter, how are the charts? >> well, i think the situation is this. and tony described quite a bit of it.

but the thing, the ipo was only in 2017, okta is ahead of tesla. you're talking about a stock that came out at $17 a share 290 is the bullish part. but a bullish to bearish reversal is something after a great run starts to stall and roll over. that's exactly what this is. you're seeing bearish price line correlation, poor relative strike, tony discussed it. and that's not a good sell a great run up and then the roll over. >> all right going to take our break now. do you guys out there miss us a lot over the weekend, here's a solution, check out the website "options action" on cnbc.com, we got a newsletter perfect for your return to brunch chat here's what's coming up next. >> adaptation of the emperor's new clothes, there's some fanciful tells about naked shorts, professor khouw corrects the record on how they really work plus calling all "options action" fans, reach into your

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♪ ♪ ♪ ♪ ing. welcome back . welcome back to "options action." amc having another big day, the stock rallying 15%. if you caught us on "fast money" this week you heard a lot of discussion around amc and naked shorts so we want to explain exactly what it is and is not. professor khouw, start us off. >> okay.

we should start talking about when you sell a stock short you are borrowing the shares, you do not already own them there's a couple reasons people might sell stock they don't already own, one is to speculate that the price might fall and they can buy it as a profit at a lower price in the future. another reason would be to hedge. sometimes will you see people shorting stock against other positions they own that's not an outright bearish bet you but they is a good reason to do it. finally, most significantly, is bonafide market activity market makers stand in the middle of the market and create lick ridity and what people look to sell shares they sell to market makers and buy shares from market makers and they maintain inventory sometimes they're long sometimes they're short. now naked shorts refer to circumstances where people selling the stock short did not first validate that they could get a borrow on those shares now there are some exemptions in

the marketplace for people to do this market makers are among the group that's get emulxemptions, it's not a hedge fund loophole there's no loophole for them there's no loophole for individual investors either. bonafide market activity does have annex exemption have an exemption. the other thing if you sell short you deliver the share at settlement which is right now two days after the current trade date the thing is there are stiff regulatory requirements around this we can actually track how much of this activity is going on by looking at something called the fail to deliver. this is a report issued by the s.e.c. and tells us each day the cumulative number of shares that those who are supposed to deliver failed to do so. not every failure to deliver, by the way, is a result of a short sell now i have heard people talk about the possibility that many times the existing float of

shares is actually out there, naked short and that we can look at these failure to deliver reports and see that actually the magnitude is significantly smaller, we did see big fails to deliver early in the year, in both amc and gme sometimes reaches as much as in the case of amc 40% of a day's trading volume but since the beginning of the year the average failure to deliver has been on average less than 2% and 70% of the time less than 1% of the average daily trading volume in either of these two stocks the important thing for people to remember, you hear these things and it sounds like there might be a loophole, there isn't, there's stiff regulatory penalties for not adhering to this you see elevated short interest, increased borrowing cost combined with ever-rising prices creates a dynamic of a short squeeze and why we see highly

volatile price action in c conjunction created by things like the wall street bets reddit crowd. >> right here's a big question, that's with so much trading in terms of total volume every day off public exchanges, carter, do you think we have a good sense of what's going on in these off-exchange platforms, whole sellers or in the dark pool? >> well, there's no way to answer that question because it is just as you say sort of the grid, dark and all of the things referred to. but what we do know is that hyper activity is not new. again, it happens in stocks all the time for generations and essentially things like amc, was down to $1.97. gme was down at $2 so while most penny sheets -- these are not penny sheet companies officially -- notification low-priced stocks

don't end up going 100 and 200,000% if you will but the circumstance of this is not new. i think that's very important. it happens to be a new era with internet and reddit and tweets but this has been going on since time in memorial. >> right tony your take >> yeah, so i don't think the bait is whether or not naked shorts exist, mike's trying to show you the fact that the magnitude of which if it does happen that we're seeing it. this is not my area of expertise but one thing i want investors understand is when you think about shorting the stock, the reason we're here to talk about options here is to protect your down side. when you're shorting a stock, whether selling short or even if you're doing it naked, you are unblim -- unlimited risk to the upside so we advocate for put spread if you're bearish like i am on okta or if you're mildly

bearish on a stock protect yourself by selling a call credit spread. that will protect you if you're caught in a short squeeze from that unlimited loss to the upside in a stock that you're bearish on. >> carter, let's go back to amc, specifically, we saw a big run in today's session, volatile week, no surprise, what are you seeing in the charts for amc. >> sure we might have one before you. so it's all sort of very sequential. if you will. before looking at the chart one judgment has to be made. the high of june 2nd, $72.62 will that be exceeded? i will say no. so now it's a question of can we trade it, this day, that day, make or lose and the hunch is, that, yes, if you get down into the 40s, low 30s, you take a shot it's back towards the 68, 70, i think you fade it. and that's the only way you can play it. i think it's important to make that statement

gamestop's high at 483, that's perfect. we are nowhere near that we're half that. i would say the 72, 62 high for amc is going to end up the high to up next, a look back on an au-related trade coming up on a milestone. we'll be back in two it's a thirteen-hour flight, that's not a weekend trip. fifteen minutes until we board. oh yeah, we gotta take off. you downloaded the td ameritrade mobile app so you can quickly check the markets? yeah, actually i'm taking one last look at my dashboard before we board. excellent. and you have thinkorswim mobile- -so i can finish analyzing the risk on this position. you two are all set. have a great flight. thanks. we'll see ya. ah, they're getting so smart. choose the app that fits your investing style. ♪♪

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no download necessary. and kim. she wanted to execute a pre-set trade strategy in seconds. so we gave 'em thinkorswim web. because platforms this innovative, aren't just made for traders—they're made by them. thinkorswim trading. from td ameritrade. . welcome back to "options action." last week tony laid out a road map for trade around advanced auto parts. >> if we take a long-term chart of advanced auto parts what you see is that this is a stock that really has made no outperformance here over the past year, past five years or so, it's actually under performed the market significantly over that amount of timeout recently two months ago started to break out not only on an absolute but on a relative basis, telling me there's potential upside for a name like

this i'm going out to july selling 190, 180 put spread, collecting $6.70 for the 190 puts paying $3 for the 180 puts, net net collecting $3.70 on a $10 wide credit spread. >> since then, this trade zoomed to a key level tony, what next? >> yeah so whenever you're able to collect more than 50% of the max gain in such a short amount of time, in this particular case, five days, it makes sense to take profits. you can buy it back at $1.50 opposed to holding it for the next 30 days hoping to make the next $1.50 so take your profits and move on to the next one. >> mike? you'd do the same? >> yeah this is a typical situation when you sell premiums, sometimes you have to wait until expiration arrives basically for that extrinsic preium to decay and sometimes

you get moffat you needed and that premium drops quickly and in those case use increase the amount relative to the reward you get for that marginal amount so makes a lot of sense to cover those whenou y can >> up next tweets and the final call stay tuned i'm searching for info on options trading, and look, it feels like i'm just wasting time. that's why td ameritrade designed a first-of-its-kind, personalized education center. oh. their award-winning content is tailored to fit your investing goals and interests. and it learns with you, so as you become smarter, so do its recommendations. so it's like my streaming service. well except now you're binge learning. see how you can become a smarter investor with a personalized education from td ameritrade. visit tdameritrade.com/learn ♪

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♪♪ welcome back to "options action." time for some tweets our first viewer asks can we get an update on gdx trade, does it make sense to take profits at this point carter what's your take >> sure, the key here is gold went 1700 an ounce to 19 in the past two months. the gdx went from 31 to 40 so up 14%. that's the beauty of operationing percent of a business gdx up three times the commodity. at this point take some profits,

ultimately higher but nothing wrong reducing your exposure your and moving on, staying in with what is left. >> mike, your two cents? >> yeah, the quick thing is, when we have options structures like this one you can adjust the trade, so you can take a portion of your profits and just use a small quantity of that to press your bullish bets going out. i think that's the way to do it, take money off the table but play for further upside down the road. >> all right our next viewer asks as someone with smaller account, i -- don't have strategy to find tickers that are good picks for spreads what are measures finding stock that's are good for this, tony, your advice? >> i would use a technical screener look for over sold stocks. try to filter stocks above $50 >> good advice there it's time now for the final call on thisfriday for "options action." carter worth, kick us off. >> adobe, up and out >> tony zhang?

>> okta buy put spread. >> mike khouw. >> adobe diagonals, buy low and play ball, sell high >> makes sense does it for "options action", be back next friday at 5:30. my mission is simple, to make you money i'm here to level the playing field for all investors. there's always a bull market somewhere and i promise to help you find it. "mad money" starts now hey, i'm cramer. welcome to "mad money. welcome to cramerica, other people want to make friends, i'm just trying to make you a little money. my job is to teach you, entertain and teach you. call me or tweet me @jimcramer stocks keep me entering in a tranquil way the dow edging up 13 points and

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