In November, I shared how to generate free profits being long Baidu Inc (ADR) (NASDAQ:BIDU). But this time, the earnings lotto wasn’t too lucky. The breakout in BIDU stock fizzled as traders sold on the news.
Fundamentally nothing has changed for the company. Baidu still is a solid bet for the long-term. The setback was from pure price action and not based on any obvious execution or operational issues. So as long as markets in general don’t correct, BIDU stock should find footing soon and remount another rally.
Even though I have good reason to go long the stock, though, I am not about to risk $173 per share on this hard line. Today, I will set a trade using the options markets that gets me long Baidu stock for free and with room for error.
How to Trade BIDU Stock
The bet: Sell the BIDU Sep $130 put. This is a bullish trade for which I collected $2.5 per contract to open. I need Baidu shares to stay above my sold strike to win. The 24% buffer from current price gives me a 90% theoretical chance of success.
I only sell naked puts if I am willing and able to own the stock at my strike price. Otherwise, I could turn this trade into a credit put spread. Yes, I would be limiting my potential profits, but I would also gain an advantage. The risk of a credit put spread is finite. When selling naked puts, I suffer losses below my breakeven point all the way down to zero.
The Alternate: Sell the BIDU Sep $140/$135 Credit put spread. I collect 95 cents per contract to open. The buffer is slightly smaller here, but I still can yield 20% on risk with 90% theoretical certainty.
Usually I like to hedge my bet and sell upside risk for balance. But in this case, I will delay this action. I don’t leave myself open to a short position going bad on me if BIDU bounces. Since I am using longer-dated contracts, I am comfortable that I will be able to manage the short term price gyrations.
The Juice (Optional): I could make my bet even more bullishly biased by adding a debit call spread. I also will delay this action until I see clear evidence of the bounce. Then I would buy the BIDU Apr debit call spread at the money. I pay half of the width of the spread for the chance of doubling my money.
I am not required to hold my trades open through expiration. I can close any of them for partial gains or losses.
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.