In November I shared how to generate free profits being long Baidu Inc (ADR) (NASDAQ:BIDU). The trade was an easy win.
Since then, nothing has really changed from the fundamental perspective in BIDU. But from the macro perspective, BIDU’s environment is now much more bullish. president Trump’s promise of fiscal spending and less regulation has ignited a wave of so called animal spirit that has carried equity markets to all time highs.
Technically speaking, BIDU stock is constructive. There is tension building around important levels that coincide with necklines that if broken upward could invite more buyers. So, BIDU stock is on the verge of a breakout with much more room to run.
Baidu earnings are coming this week and I want to be long the stock. I am not going to risk my money into a binary event. Instead, I will use BIDU options to go long for free.
The Bet: Buy the BIDU March 31 $187.50/$190 debit call spread. This is a bullish trade for which I pay $1 to open. This is my maximum potential risk. If BIDU rallies past my spread by mid-March I can double my money. I could move this spread higher to lower my entry cost, but that would also reduce my chances of success. By keeping the spread I buy close to current price, I only need to guess the direction of the move rather than the size of it. Usually I like to mitigate my risk and in this case I want to lower my out of pocket expense. So I will sell longer-term downside risk against levels I deem safe in the current environment.
The Bank: Sell the BIDU June $140 put. This is a bullish trade for which I collect $1.10 to open. I will tightly manage my open risk. BIDU options are liquid enough to allow for easy management of long-term commitments. The 24% price buffer gives this trade a 95% theoretical chance of success. The breakeven for this trade is $138.90 and anything lower would accrue losses on this side. Selling naked puts is dangerous and I only do it if I am willing and able to own the BIDU stock at the sold strike. I could modify the trade to better suit milder risk-taste and small accounts.
The Alternate Bank: Sell BIDU June $150/$145 credit put spread. This, too, is a bullish trade where I collect 55 cents per contract to open. In this case, the maximum risk is limited to the width of the spread less what I collect to open. The price buffer is slightly smaller here but still carries a 90% theoretical chance of success.
I am not required to hold these trades open through expiration. I can close any of them at any time for partial gains or losses. As long as BIDU stays above my sold risk, any premium I collect from selling the debit call spread is profit.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
