Trading momentum stocks like Baidu Inc (ADR) (NASDAQ:BIDU) requires surgical precision when using the equity. Entry into such a fast-moving stock is tricky because on the way up it seems perpetually overpriced and on the way down like a falling machete. Often investors are left out waiting for a perfect entry point that may not come.
Using options to trade BIDU slows down the action so that I can trade it with relative confidence. Case in point, in late February I shared a trade that turned out to be a huge winner and this wasn’t a fluke. About a month earlier I had also written about a bullish Baidu trade that also delivered profits out of thin air.
The impressive part is that the price action was choppy and didn’t need perfect entry or exit points.
It’s also important to note is that in both of these trades I used no money out of pocket and didn’t need perfect price action to profit. So today I want to stick with what’s working and repeat performance only this time on a different time frame.
Click to Enlarge Fundamentally nothing has really changed. BIDU stock is still not cheap from a price-to-earnings perspective but for as long as I continue to consider it as a growth company I don’t really care about value. Growth is what’s important for now and value would follow, much the same way I evaluate entry points into Amazon.com, Inc. (NASDAQ:AMZN).
I know they are expensive from the traditional sense, but that’s the case with any company which is focused on growth.
BIDU Stock Trade Idea
The Bet: Sell the BIDU Dec $125 put and collect $1.75 per contract. This is a bullish trade where I have a 90% theoretical certainty that the stock will stay above my risk so I could retain my maximum gains. Otherwise I will accrue losses below $123.25 per share.
Usually I like to sell upside risk to balance the trade, but in this case I will delay entry into a BIDU credit call spread respecting its upside potential. With more than a 25% price buffer from current level, I am comfortable that I will be able to manage the long-term risk against any short-term price gyrations. Even then, I could buy cheap sacrifice puts for temporary crash protection during periods of uncertainty.
I could modify this trade into a credit put spread so it would have a finite risk profile. The idea would then better suit someone with a more modest taste for risk yet still deliver 10% yield. Compare this with having to risk $180 per share without any room for error then need the stock to rally 10% in the next few months.
E-mail sellspreads@gmail.com with questions or join me to learn more about options in a personal 1on1 webinar here. 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.
