Palantir Technologies has experienced a significant rally this year, with its stock price appearing stretched as its 14-day Relative Strength Index (RSI) nears overbought levels. Concurrently, the cost of downside protection, as indicated by the PutDex index, is unusually low, making put options exceptionally cheap even as the stock trades near its year-high. This unusual market dynamic suggests investors should consider options strategies, like buying puts or a put spread, to protect gains against a potential pullback, especially when market euphoria seems to be mispricing risk.
Palantir Technologies (PLTR) has been a significant market story this year, showcasing remarkable momentum with gains exceeding 65% since its low on June 25. The stock further cemented its bullish trend on Friday, rising approximately 3.5% to trade above $180. However, a closer look at two critical numbers suggests that both existing shareholders and opportunistic traders should seriously consider protecting their accumulated gains.
The first indicator highlights that Palantir's stock price might be stretched. Its 14-day Relative Strength Index (RSI), a widely observed momentum indicator, registered 69.50 at midday Friday. Given that an RSI above 70 is generally considered overbought territory, Palantir is on the verge of entering this zone. While RSI isn't a precise timing tool – strong stocks can maintain overbought levels for weeks – it effectively communicates how much positive sentiment and news are already factored into the share price. Following Palantir's impressive rally, it's evident that a substantial amount of good news is already reflected in its valuation.
The second number reveals an even more compelling situation: the cost of protecting against a downside move has rarely been cheaper. Our internal PutDex index, which normalizes the price of a 30-day Palantir put option one standard deviation below the stock price, is currently hovering in the bottom decile of its 52-week range. In simpler terms, put options – which institutions typically acquire as insurance against significant declines – are trading near their lowest prices of the past year, even as Palantir's stock sits near its annual peak.
This combination is notably unusual. Typically, when a stock experiences a sharp ascent, buyers flock to put options to safeguard their profits, causing the price of downside insurance to increase. The inverse is occurring with Palantir: traders are so intensely focused on chasing further upside that equivalent out-of-the-money call options are actually more expensive than comparable puts. This pricing anomaly is usually observed only in the most 'frothy' segments of the equity market, indicating minimal fear among PLTR long positions – precisely when purchasing insurance becomes most prudent.
Here’s a practical look at a potential trade: With Palantir trading at $180.85 midday Friday, a September 25 expiration $170 put, with roughly five weeks remaining until expiration, could be acquired for $5.90, equating to $590 per contract. The maximum risk for this position is the premium paid. This trade becomes profitable if PLTR falls below $164.10 at expiration, representing a decline of approximately 9.2% from the current price. For a stock known to move 5% in a single day due to news, such a pullback is not improbable, and the trade offers dollar-for-dollar gains below that breakeven point.
For traders seeking to reduce the initial outlay, a put spread offers an alternative. By purchasing the same September 25 $170 put and simultaneously selling the $155 put, the net cost is reduced to around $3.60, or $360 per contract. While this short strike caps the maximum profit at $11.40 (the $15 difference between strikes minus the net premium), the spread achieves this maximum profit if shares close below $155 at expiration. This strategy risks $3.60 to potentially gain $11.40.
The core premise of this strategy isn't a prediction of Palantir’s collapse. Instead, it’s a tactical move based on the idea that a stock priced for perfection, with momentum nearing overbought conditions, is susceptible to an ordinary market pullback. Furthermore, it capitalizes on the options market’s potential mispricing of this possibility, as it appears distracted by the pursuit of further upside. Long-term stockholders can view the put option as affordable insurance for their accumulated gains, while traders can utilize the spread as a defined-risk approach to counter the prevailing market euphoria. In either scenario, when the market offers such inexpensive protection on a stock that is visibly extended, the sagacious decision typically involves eschewing conventional wisdom and securing that protection.
