I was a little too eager to call an end to the twilight phase in my Seeking Alpha post two weeks ago. I did not anticipate the large run up in the stock, but probably should have. At the peak of a bubble, it is normal to see a test of the highs.
As the stock rose last week, I shorted shares, but did not add to the options positions. Risk control is easier when shorting a stock outright than in buying put options, because I can set a stop limit that is logically derived. For 3D Systems Corporation (DDD), the natural stop limit would be in the $72-73 range, because this is the all-time high for the stock. If it were to blow through this point, it will have passed a test, and the reflexive boom phase could continue for the foreseeable future.
However, it seems that this week has shifted the momentum back to the negative. I feel more secure in the short position now. In a reflexive bust, the further the stock declines from the high, the more likely it is to continue declining, until the stock reaches undervaluation territory. For DDD, I would not be interested in investing on the long side until the stock nears $30/share.
The only risk to the bust process at this phase is the upcoming earnings announcement on February 25. I suspect these earnings will show high growth rates, because the stock was so highly priced during the fourth quarter that 3D Systems Corporation could spend freely on capital expenditures and acquisitions for growth.
This alone would be a positive event for the stock price. However, the perception on the stock has already shifted. According to George Soros’s model of reflexive boom-bust processes (see model in my DDD article here), it is typical for the stock to continue declining for a significant period after the peak, even as earnings increase. That is, the peak in earnings typically follows the peak in stock price (this is due to the delay of acquisitions’ effects on earnings, coupled with the 1-2 month delay in reporting earnings). So good earnings will not necessarily de-rail the bust process.
But it pays, in the long run, to be cautious. Therefore I will likely reduce my short position before the end of next week to lower my exposure to an earnings-related upward move. But, in the mean time, I am letting my profits on the short position run, and am considering adding to it to cash in on a likely move downwards during the beginning of next week.
Disclosure: I am short DDD via stock sales and the purchase of March and May $45 put options. I am considering shorting additional shares of DDD in the next 72 (business) hours.