y were to ask him, he would probably rather have a rival put a bullet in his head, than to be sitting where he is now and that part makes me feel good. ♪♪ -- captions by vivit -- ♪ happy friday and welcome to "options action. i'm melissa lee. here is the lineup for tonight which adobe is it? a solid winner going into earnings week or a figurative dried mud brick. tony zhang continues to rain on cloud computing place find out which name he thinks won't strike twice plus, naked. now that we have your attention, professor busts myths ant naked

shorts and the mean stocks it's time to risk less to make more "options action" starts right now. adobe is out with earnings next week. mud bricks thinks this name is solid and strong carter, what do you see? >> i do. and it's timely. now, one of the things about timing is you can get the direction wrong, but we're playing for a breakout in response to earnings several charts the first is a two panel and 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 breakout is that after some backing and filling and typically can exceed a prior high really equally important, and the absolute level is the relative, the bottom panel, that is relative performance to the s&p 500. what we know is as adobe has gone sideways for 8, 9, 10 months it is by definition gone

down relative or underperforming. c, it's just starting to show relative outperformance to the s&p. that's very important. several ways to draw the line to the abslult adobe chart. first, you see there, you can call that ascending triangle or a 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 ten months the next one, cup and handle again, call it whatever you want, but these formations over time throughout history, not infallible have been reliable more often than not. the next one, is it a head and shoulder, bottom of sorts within this consolidation pattern final one, putting a couple of them together. essentially a key moment and a key former high. now you make your bets and think it will break out and exceed the former high. >> all right so mike, what is the trade here for adobe? >> yeah.

so, adobe we obviously have the stock trading essentially at all-time highs right here, right now. that might make it a tough reach to go out and actually buy the shares obviously 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 advantage of that dynamic i would point out right now this company not cheap, trading 40 times forward earnings, 42 probably, but that's below the five-year average of about 44 times. one of the reasons for that, we have 20% top line growth and there's a lot of good tail wind 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 tail wind so, one way to make a bullish bet is to buy a longer dated september 540 call those are trading over $28 and then look to sell some of

that elevated short dated premium i was looking at the june 555 calls those were just under $5 net/net you 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 ensure you can't be wrong if the stock overshoots your upside target here that's not quite the case because we're laying out just over $23 and the distance between these strikes is 15. that said, the stocks really going to have to make a strong move by the end of next week for this to be a loser to the upside we're really trying to take advantage of that implied volatility dynamic own longer-dated calls and also lay out less premium than buying these relatively high-priced shares outright. >> tony, what's your take on adobe and what's your take on the rade >> i quite like this because as carter's charts show you, you

have a very clear breakout after a long consolidation period. but the most important part is that relative strength factor that carter was showing you. i think he showed adobe relative to spy breaking out relative to market but it's also breaking out relative to technology as well, its sector match that's extremely constructive heading into earnings. 20% top line growth. 40% profit margins and the fact that 90% of their business comes from subscriptions and they're a clear leader in their particular space leads me to believe they'll have another strong quarter here as mike's trade here is a great example of taking advantage of this term structure skew where he's selling shorter dated higher implied volatility options and buying lower implied volatility, longer dated options. as he said, the risk here is really if you do get a significant up shoot of this particular stock you could underperform, but he is only risking 4.5% of the stock's

value to take this trade and i think it's a great way to play upside on a stock trading all-time highs. >> mike, last word on this trade? >> yeah. the critical thing here and this is fairly familiar phenomena, we obviously had a long bull market, we have a lot of stocks trading essentially at their all-time highs, not necessarily their all-time peak multiples which speaks to the operating strength to a lot of these companies. adobe is a good example. there's two things you want to pay attention to, obviously the market capitalization, the top valuation but also how does that compare to the historical valuations to some of these businesses some of these companies are trading at lower multiples than they have on average over the last two to five years. >> tech here, cloud security company okta had a nice run but tony things there's too much fog in the forecast for this company. tony, what do you see? >> yeah, that's exactly right. security is at the top of mind

for a lot of investors i think on this particular cloud security stock there is potential downside here. if we take a look at the chart itself here, the stock is trading very wide range between 210 and 290. recently we have seen lower highs here it did have a strong week and the strength here this weak is the opportunity to look for some short exposure as a test that 210 support level. the reason it could potentially break that major support level because if you look at the stock relative to its sector, xlk, it's already broken those support levels that is a suggestion we could see some further declines. and 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 pretty decent at 20, 25% year over year, but eps is down 82% over that same amount of time especially when you have a stock that's trading at extremely rich valuations at 30 times sales and quarter over quarter revenue growth has slowed down to single

digits, that's a recipe that i think will be hard for these stocks to sustain this valuation. so, the trade structure that i'm using reflects what i see as potential sizable downside if it does break below that $210 support level is to take advantage of the fact that implied volatility here is extremely cheap. it's actually in its lowest we have seen over the past year by going out to august and buying the 220, 190 put spread here, i'm paying about $11.90 to pay for the august 210 puts, that's out of the money put, then i'm selling the august 190 puts against it, collecting $3.30, paying net/8.60 which is less than 40% of the stock's price. the reason for this is just because we are going into a strong market, taking a bearish position is not particularly favorable for a lot of investors, so trying 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 we try to look at put spreads, we try to take advantage of the fact -- sometimes we try to take advantage of term structure, sell the most expensive, that also applies when you're looking at the money options versus out of the money puts typically out of the money puts will trade at higher implied volatilities gets the math working for you oftentimes with the put spreads looking for 3 to 1 payoff. this doesn't quite achieve that but that's justified within the last two months, this stock is trading $290 to get down to that 190 strike, 225, not a big move given how much the stock has demonstrated it can move and so i think this is a 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 ipo

was only back in 2017 okta is ahead of tes larks a stock that came out $17 a share, hit 290. that's the bullish part. but a bullish to bearish reversal is something that after a great run starts to stall and roll rollover that's exactly what this is. poor relative strength tony discussed it. that is not a good setup great run-up and then the rollover >> all right going to take a break now. do you guys out there miss us a lot over the weekend check out our website optionsaction.cnbc.com. here is what's coming up next -- >> adaptation of the emperor's new clothes. tales out there about naked short. professor corrects the record with a cliff's note version on how they really work plus, calling all "options action" fans reach into your pocket, grab

your phone and tweet us your question @optionsaction if it's nice, we'll answer it on air when "options action" returns. ♪ wondering what actually goes into your multivitamin?

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♪ ♪ ♪ ♪ ♪ 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 wanted to take a moment to explain this concept what exactly it is and what it is not. professor khouw, start us off. >> okay. we should start talking about rz what shorts stocks is to begin with when you sell a stock short what's going on is you're borrowing the shares, you do not already own them there's a couple reasons why people might sell stock they don't already own. one is to speculate the price might fall and buy it back at a profit at some lower price in the future another reason would obviously be to hedge. sometimes you'll see people shorting stock against other positions that they own. so that's not an outright bearish bet, but they have a good reason to dpoit finally, one of the most significant reasons is just for bonn fied market making activity they create liquidity. people are looking to sell shares, they are often selling to market makers and buy shares they're buying from market makers and maintain inventory. sometimes they're long

sometimes they're short. now, naked shorts refer to circumstances where people who are selling the stock short did not first validate that they could actually get a borrow on those shares now, there are some exemptions in the marketplace for people to do this. market makers are among the groups that get exemptions we sometimes hear about people having -- institutions having loopholes. it's not a hedge fund loophole there's no loophole for them there's no loophole for individual investors either. it does have an exemption. the other thing i would quickly point out is the whole issue here is whether if you sell stocks short you are actually able to deliver the shares at settlement, which right now is two days after the current trade date the thing is, there are stiff regulatory requirements around this so we can actually track how much of this activity is going on by looking at something called the fail to deliver so, this is a report that is issued by the s.e.c. and it 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 the result of a short sale 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 than that. we did see big fails to deliver early in the year in both amc and gme. sometimes reaching as much in the case of amc as 40% of a day's trading volume, but since the beginning of the year, the average failure to deliver has actually been on average less than 2%. 70 plus percent of the time it's been well less than 1% of the average daily trading volume in either of these two stocks so the important thing i think for people to remember is you hear these things. it sounds like there might be a loophole there's a magic way to do it, there isn't. there's stiff regulatory penalties for not adhering to

this and really what people ought to focus on when you see elevated short interest, see increasing borrowing cost, that combined with just ever rising prices that creates the dynamic of a short squeeze that's one of the reasons we see that in conjunction with all the momentum created by things like the wall street reddit credit. >> here is a big question and that is with so much trading in terms of total volume everyday, off public exchanges, carter, do you think we actually have a good sense of what is going on in these off exchange platforms, you know, wholesalers or in the dark pool? >> well, there's no way to answer the question because it is just as you say, sort of off the grid, dark, all the things that they refer to but what we do know is that hyper activity is not new. again, it happens in pink sheet stocks all the time for

generations and things like amc. amc was down at $1.97. gme was down at $2 so while most pink sheets and these are not pink sheets companies officially, most low price 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, reddits and tweets but this has been going on since time and memorial. >> right tony, your take. >> yeah. so i don't think the bait here is whether or not naked shorts exist. i think what mike is trying to show you the fact of the magnitude which if it does happen that we're seeing it. i will say this is not particularly my area of expertise, but the one thing i really want to help investors better understand is when you're thinking of shorting a stock, the reason that we're here to talk about options here is to protect your downside. when you're shorting a stock, whether you're doing it selling

short or even if you're doing it naked, you have unlimited risk to the upside. so that's why we advocate for using strategies like a put spread if you're very bearish on a particular stock or if you're more mildly bearish on a particular stock, protect yourself by selling a call credit spread. that's going to protect you if you are 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 big run in today's session volatile week, no surprise what do you see in the charts for amc? >> sure. and we might have one here before you so it's all sort of sequential, if you will. before looking at the chart, one judgment does have to be made. the high of june 2nd $72.62 will that be exceeded? i would say no right? 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 it down into the 40s, low 30s i think you take a shot at it. if it's back towards of sort of the 68, 70, i think you fade it and play it. that's the only way you can play it it's important to make that statement that game stops high at 483 that's perfect we're nowhere near that, right, we're half that. 72.62 high for amc is also going to end up being the high >> all right up next, a look back on an auto-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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welcome back to "options action." last week tony laid out a road map for a trade around advanced auto parts >> if we take a long-term chart here 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 and actually underperformed the market significantly over that amount of time but recently two months ago it started to break out not only on an absolute but also relative basis. so this is telling me that there's a potential upside here for a name like this i'm going out to july. i'm selling the 190, 180 put

spread here, collecting 6.09 paying $3 for 3.80 collecting 3.70 on 10 dollars wide credit spread. since then this trade zoomed to a key level tony, what next? >> when 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 makes sense to take profits. buy this back 1.50 opposed to hold for 35 days so take your profits and move on to the next one. >> mike? you would do the same? >> yeah. this is a typical situation when you sell premiums sometimes you have to wait until expiration arrives basically for all that extrensic premium to decay sometimes you get the move that you really needed and that extrensic premium dropped very

quickly. in those cases you begin to increase the amount that you're risking relative to the reward you get for collecting that marginal amount. it makes a lot of sense. 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 first viewer asks, can we get an update on the gdx trade? it has worked well and would like to know if it makes sense to take profits at this take? carter >> sure. gold, gx went from 31 to 40. gold goes up 14% and that's the beauty of rating leverage of a business gdx goes up 31 at this point i think you take profits, ultimately higher, re reduce your exposure and staying

in with what is left. >> mike, your two cents? >> yeah. the quick thing is when we have option structures like this, 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. >> all right our next viewer asks, someone with a smaller account, i like verticalspreads due the mauler amount of premium needed however i don't have a strategy to find tickers that are good picks for spreads. what are methods for finding stocks that are good for this? tony, your advice. >> i would use a technical screener, look for some oversold stocks but try to filter out stocks that are above $50. >> all right good advice there. it's time for the final call on this friday for "options action." carter, kick us off. >> adobe up and out. >> tony zhang? >> okta, buy a put spread.

>> mike khouw. >> adobe, buy low and sell high and play ball. don't go anywhere. "mad money" with jim cramer starts right now - [narrator] the following program is a paid advertisement for nuwave oxypure smart air purifier, sponsored by nuwave llc. featuring deborah norville. an award winning journalist and new york times best-selling author. deborah is here today to share her passion for the nuwave oxypure. - we've been living through strange and unsettling times. never in history has everyone on the planet been confronted by the same thing. and we're still trying to get back to a sense of normalcy. we've discovered how devastating a virus can be and the importance of proper cleaning.