Three weeks ago, Square Inc (NYSE:SQ) delivered a mixed earnings report yet traders after a little hesitation ran it up 35% in 16 days. Unfortunately for late-comer bulls, Monday the stock fell off a cliff on a headline.
But therein lies the opportunity. The dip was based on one downgrade from one opinion. Today I want to bet that they are wrong. So I sold downside risk into what others fear. If my levels hold then I would have created income from nothing.
Square stock is obviously as a momentum stock. Those are tricky to trade because they move too fast. On the way up they perpetually seem ready to correct. On the way down, they appear to be falling into an abyss. In either case, most traders are scared out of trading them. Using options makes it much easier to profit from the momentum.
For example, a trader that wanted to buy it two months ago but didn’t, now has the chance for another opportunity to do so. I choose a level and sell puts against it for a chance to buy SQ shares at a discount.
Yesterday, I was fortunate to sell Dec 8th $38 puts naked in the morning. By mid afternoon, the stock bounced hard so I booked the profit at 50% of maximum gains. So I come into this trade with profits in hand.
Until Monday, Square stock had the wind in its sail. While Visa Inc (NYSE:V), Mastercard Inc (NYSE:MA) and Paypal Holdings Inc (NASDAQ:PYPL) were up 45% to 95%, SQ was up more than double the most. Even after this week’s dip the stock is still up 212% year-to-date.
The sector is doing well thanks to our shopping habits migrating online at a neck-breaking rate. SQ stock stands to benefit from it. The stock fell on Monday after one negative note. Someone’s opinion doesn’t change the actual prospects for the stock. As long as management continues to execute on plans, this company will continue to prosper.
Click to Enlarge There is also the added potential from their future loan business. So their growth path is likely to stay strong for a while. As they mature, they will attract larger customers, which will help feed other ventures.
Since there is no tangible value, I chose my levels based purely on price action and prove pivot levels.
SQ Stock Trade Idea
The Bet: Sell the SQ Jan 2018 $34 naked put. This is a bullish trade where I collect 70 cents to open. Here I have a 85% theoretical chance of success. But if price falls below $33.30 then I accrue losses.
Selling naked puts carries big risk, especially for a stock as frothy as Square. To mitigate it, I can sell a spread instead.
The Alternate Bet: Sell the SQ Jan 2018 $34/$32 credit put spread. The spread has the same odds but would deliver 35% yield on risk. Neither trade require a rally to profit.
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.