iRobot (IRBT - Get Report)  is down down more than 8% at $97.21 Monday afternoon following an analyst downgrade, but the name is still up some 25% year to date. How should you play the stock here?

First, let's see what's going on. iRobot, which makes the popular Roomba robotic vacuum cleaners and other robotic home appliances, is falling after Piper Jaffrey's five-star analyst Troy Jensen downgraded the stock Monday to "Neutral" from a previous "Overweight." Jensen did this while leaving his price target where it was, at $90.

The analyst isn't all that concerned with iRobot maintaining its dominant market-share in the industry. Instead, Jensen wrote in a note that he's become "incrementally more concerned" with iRobot's valuation as the stock ran higher and higher throughout the year.

Jensen also sees iRobot as a victim of already-implemented U.S. trade tariffs that will likely impact 2019 company guidance. He recommended current shareholders use any rally stemming from the release of third-quarter earnings results due Oct 23 as a selling opportunity. Wow! Tell us how you really feel, Troy!

Well, I'll tell you how I really feel. First, iRobot is obviously a dangerous stock. Trading at 30 times forward looking earnings, the stock had been hot based on rising margins -- margins that Jensen expects to fall on rising input costs.

But iRobot isn't in any kind of trouble so far. Both its current and quick ratios show that the firm can meet its short- to medium-term obligations.

And then there's the short interest. Yeah, that matters here. Just as those betting against Tesla (TSLA - Get Report) are one of the main reasons for that stock's resiliency, maybe you can expect the same kind of support for IRBT.

There were 8.1 million shares of iRobot held in short positions as of mid-September -- or more than 30% of the stock's total float. To me, that means that the same pop that Jensen thinks that those third-quarter earnings results might create -- and that he thinks long sellers should sell -- might just be exacerbated by a short squeeze.

However, technical analysis shows us that iRobot's daily Moving Average Convergence Divergence Oscillator (marked "MACD" in the chart below) turned negative in early September and has never looked back,. A month later, both iRobot's Relative Strength Index ("marked "RSI(14)" below) and Chaikin Money Flow ("CMF(20)") have also turned downward:


On the plus side, iRobot's 38.2% Fibonacci-retracement level passed its first test Monday morning. That doesn't mean that this name is out of the woods, but it is a positive. People have profits here, making this a dangerous name in a down market.

How to Play iRobot Here

Should you decide to buy iRobot on this dip, I recommend writing a covered call against your position in order to reduce your net basis. But don't do a put. If Jensen is right about iRobot, you don't want any added exposure to equity risk.

So, here's what I'd recommend:

  • Buy 100 shares of IRBT at or close to $94.61, which is the first line of Fibonacci support.
  • Sell (write) one Oct 26 $120 IRBT call (last price: $1.50).

This sale caps your profit on a two-week timeline at $120, but also reduces your net basis to $93.11. And instead of setting a target sales price, I would make Oct. 26 my target sales date. In other words, make sure that you're out of the stock by then.

(This article has been updated.)