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‘Strangling’ Baidu Ahead of Earnings

A strangle play, using both long calls and long puts, looks good


Earnings season continues to roll on with Chinese Internet search company Baidu () stepping front and center on Monday, July 23 with its latest quarterly results. The average analyst EPS estimate on Wall Street stands at $1.13, up 56.9% from its year-ago earnings of 72 cents per share. In addition, analysts are expecting a 61% rise in its revenue from the same period a year ago to $851.6 million.

Historically, the company has put in a strong showing when it comes to its earnings performance. It has surpassed the Street estimate by an average of 4% during the past four quarters.

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Wall Street remains in the stock’s corner, with 14 of 16 analysts who offer an opinion on the Beijing-based company giving it a strong buy rating, while the remaining two rate it a hold.

But has the stock earned Wall Street’s love?

Not lately. After topping out near the $150 level in late April, the share price has suffered a steady decline until finally hitting a low at approximately $100 on Tuesday. Furthermore, the security has stumbled steadily lower under its 10-day and 20-day moving averages during this time frame. The equity is now down more than 28% over the past 52-weeks.

Adding to the stock’s woes, it has been beaten lower by staunch resistance at its 10-week moving average and is now hovering at key support at round-number level $100.

While the technical backdrop doesn’t look pretty, this could prove to be an excellent entry point for options traders. The $100 level has been key support for the shares since the start of 2011. In fact, the last time they bounced off the century mark, the equity went on to rally to $150 during the next month.

On the other hand, a serious breach below $100 could finally shake loose a number of longer-term shareholders, resulting in a sharp sell-off. Also, BIDU is vulnerable to a round of analyst downgrades should it fail to turn its performance around.

Looking at the options picture, we find that short-term speculators are focused on the stock’s puts. The August 90 put is the site of more than 14,000 contracts, while the August 105 put has accumulated more than 13,000 contracts. This is in sharp contrast to the call side, which has fewer than 4,000 contracts at its most popular August strike. In short, options players are looking for BIDU to continue its slide.

Heading into the company’s earnings report, the table is set for a potential sharp move, and options players should position themselves to take advantage of such volatility. Since a “strangle play” uses an equal number of both long call and long put positions, a trader can capitalize on a rally following a positive earnings surprise or a sharp drop below the key $100 level.

The August 110 call was last priced at $4.70, and the August 105 put was also priced at $4.70, bringing the total price of the straddle to $9.40, or $940 for one call and one put contract. With the stock closing on $107.45 on Wednesday, the strangle player would need the shares to move approximately 11% to breakeven before the options expire on Aug. 17.

If a strangle play feels a little too aggressive ahead of the earnings report, traders should wait until after the results are released. A breach below the $100 level could prove to be a great signal to acquire an intermediate-term put position. On the upside, I would be inclined to wait until the stock made a weekly close above it 10-week simple moving average before I’d be willing to believe that BIDU was on the mend and ready for a call position.

As of this writing, Jocelynn Smith did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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