Baidu Inc (ADR) (NASDAQ:BIDU) reported earnings last night but unlike Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL), Amazon.com, Inc. (NASDAQ:AMZN) and Microsoft Corporation (NASDAQ:MSFT), this one fell 11% in after-hours trading. The selling continues this morning. Traders are rotating out of it and into the slew of other stocks that are setting records today.
The company clobbered the earnings expectations for the current quarter and beat on revenue as well, but came in light with their forward forecast. This is proof that short-term reaction to earnings is a coin flip and has nothing to do with the actual results.
Today I want to take the other side and add to my longs. But before you label me crazy, know that I will have a giant margin for error.
Baidu is a momentum stock, and when it falls few traders dare to catch it until it’s too late. Today I will use BIDU options to bet long even here. Typically experts recommend to stick to the three-day rule, where the selling is supposed to last three days.
I am not being reckless; I am conservative. Today’s trade will have a giant moat around it. BIDU will have to continue falling for another 30% before I start losing money. I am not looking to profit from an immediate bounce. I am betting on proven support to hold.
While traditional investors wait for signs of stabilization before they buy BIDU shares, I am willing to collect a premium today for the opportunity to own the shares at a discount. If the price never reaches my level, then I keep the premium I collect as income. No money leaves my pocket in this case. Otherwise I own the shares but much lower than today.
Fundamentally, with a 45 trailing price to earnings ratio BIDU is not cheap. From that perspective, it’s more expensive than GOOGL but only a fraction as bloated as AMZN. Clearly, I am not betting on value today, but rather on the price action inside this uber-bullish equity market.
Coming into this earnings report, BIDU stock had been up 60% year-to-date, which is around triple that of GOOGL or the QQQ. So a dip today merely brings it back down from the stratosphere. Technically, the stock was so tight that a move was imminent. This dip here could satisfy the measured target upon the loss of the rising wedge. Yet the price action could still continue inside its ascending channel higher after it finds footing.
Therein lies the secret: Where will BIDU stock find support? The $230/$220 zone had some consolidation a few weeks ago and it has been in contention for over three years, so both sides are likely to fight for it here. Below that there is a void all the way down to $190 per share, where the biggest consolidation level in the past five years sits. That should be bulletproof.
Click to Enlarge Sentiment on Wall Street had been overzealous partially due to management rhetoric in July. BIDU stock shot up like a rocket ship. When profits come as fast as they came into BIDU in the past three months, they tend to leave even faster.
This dip may not be a one-day event. Markets tend to overshoot in either direction. So I am confident that I may not catch the very bottom … but that is never my goal.
BIDU Stock Trade Idea
The Trade: Sell the BIDU Apr 2018 $170 naked put and collect $1.50 to open. Here I have 85% theoretical odds of winning, but if the price falls below $168.50, I will accrue losses.
Selling naked puts carries big risk, especially in a stock this expensive and this violent. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the BIDU Apr 2018 $180/$170 credit put spread, where the risk is limited. Yet if the spread wins would deliver 10% in yield.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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 as @racernic on twitter and stocktwits.
