Sometimes, a surge of trading volume in the derivatives market may signal an important move for affected public companies, thus drawing interest toward unusual options activity. However, in other times, it’s simply a distraction. Fundamentally, the latter may be the case for Carvana (CVNA), suggesting that investors ought to be extremely careful before making major moves with the used-car retailer.
A clear beneficiary of the COVID-19 pandemic, Carvana initially swung higher as Americans were forced to make quick adjustments to the new normal. Suddenly, residents of major metropolitan areas – particularly in the east coast – that previously enjoyed access to robust public transportation networks began looking into buying personal vehicles, often for the first time.
Throughout 2020 and much of 2021, fears of COVID infections ran deep. Therefore, Carvana in many ways represented a godsend. Through the convenience of their living rooms, customers could search for their perfect ride, having access to a nationwide network. Once identified, Carvana would then ship the vehicle to their front door, keeping physical interactions to a bare minimum.
However, as AP reported, fears of COVID-19 gradually faded as people acclimated to the paradigm shift. Unfortunately, that sentiment spelled doom for CVNA stock, which is down a staggering 92% over the trailing year since the close of the July 27 session.
Nevertheless, Carvana is the subject of bullish trading activity, raising many eyebrows.
Unusual Optimism for the Otherwise Embattled CVNA Stock
Upon the conclusion of the midweek session, CVNA stock received a surge of demand for call options at varying strike prices, all with an expiration date of Friday, July 29. With only two sessions until these contracts go worthless, traders are apparently relying on a quick scalp to secure some profits.
Of the three peculiar trades on Wednesday, orders for the $28 calls represented the most unusual. Volume reached 20,732 contracts against an open interest reading of 331. With CVNA stock closing at $26.36 in the open market, the security needs to move up over 6.2% to be in the money.
If premarket trading is anything to go by, those hoping to make easy money on this trade may be sorely disappointed. Still, market makers were willing to entertain the transaction at a reasonable bid-ask spread. As represented by the midpoint price (83 cents), the spread came out to 6%, certainly not the narrowest figure but quite reasonable for the underlying risk.
Still, despite the unusual interest in CVNA stock in the derivatives market, most investors may be better served staying on the sidelines. Fundamentally, the soaring inflation rate has dampened consumer sentiment for big-ticket items, implying that Carvana may have more challenges ahead before circumstances start improving.
Don’t Ignore the Cash Burn
As if the 92% trailing-year loss wasn’t troubling enough, CVNA stock has another glaring problem that all prospective investors or speculators should consider before taking a bullish position. Throughout its time as a publicly traded company, Carvana has been burning a lot of cash.
For the full year 2020, free cash flow (FCF) was in the red to the tune of $968 million. In the following year, FCF loss expanded to $3.15 billion. The trend is not improving as on a trailing-12-month basis, the company is looking at an FCF burn of $3.35 billion. Further, in the first quarter of 2022, this metric came in at a loss of $813 million.
Just as worrying, on the balance sheet for the most recent quarter, Carvana only had $247 million of cash on hand. Therefore, it can’t continue absorbing crimson ink on the FCF line without borrowing or raising capital. Under an environment of increasing borrowing costs, the attempt to raise cash could be detrimental to existing CVNA shareholders.
More critically, the company’s business model is not really appropriate in an inflationary cycle. While having cars shipped to your door is convenient, this service isn’t free, leading to a higher premium for the vehicles relative to traditional used-car dealerships.
That’s always going to be a tough sell when people are limiting their purchases.
Go with Common Sense
Frankly, the narrative for CVNA stock comes down to common sense. People need cars so I’m not exactly bearish on the concept of used-car dealerships. However, it’s difficult to imagine people paying unnecessary premiums for vehicles or any product category. Therefore, it may be best to avoid the recent spike in activity for CVNA stock.
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