Square Inc (NYSE:SQ) delivered a mixed earnings report last night. It beat on the top line, but missed on the bottom line, which is OK in my book, especially for a company that is growing. I’d rather see a beat on the revenue and a miss on earnings than the other way around. However, guidance was less than enthusiastic, which is why SQ stock is down 2.5%.
But therein lies the opportunity. If Square management continues to execute this well, this dip will likely turn out to be an entry point. But, most traders may not be brave enough to catch this falling knife this early.
Coming into its earnings SQ stock was up 200% in a year. So it’s obvious that it qualifies as a momentum stock.
Momentum plays like Square stock are tricky to trade using traditional means of investing. On the way up they always seem ready to correct. The opposite is also true because when they fall, they look like falling machetes. In either case, few would be brave to trade them for fear of being too soon or too late.
How to Play SQ Stock
Today, I want to take a bullish bet on SQ stock. But instead of buying the shares and risking $37-per-share with no room for error, I will use options. There I can sell downside risk into what others fear to profit. If I choose proper levels, then I create income with no money out of pocket.
Square stock has the wind in its sail. It is the exciting new-comer operating in a sector that is so much in favor on Wall Street. Visa Inc (NYSE:V), Mastercard Inc (NYSE:MA) and Paypal Holdings Inc (NASDAQ:PYPL) are all up 40% to 80%. It is hard to short any of them for too long, which makes the upside path easier.
Aside from what they are already doing right from a transactor perspective, there is also the future potential of its loan business. So their growth path is not likely to wane for a long while. They are now attracting larger customers, which should accelerate their growth even further.
So, is it too early to go long? No. But I don’t like to bet on hopium for rallies and that’s why I use options. There I can still participate to the upside while leaving room for error.
The Trade: Sell the SQ Jan 2018 $30 put for 80-cents-per contract. This is a bullish trade, which has an 80% theoretical chance of success. But if the price falls below my strike, then I own the shares and would suffer losses below $29.20.
Selling naked puts carries big risk, especially in a stock that has rallied so much already. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the Jan 2018 SQ $30/$28 credit put spread where I have about the same odds of winning, but with much less risk. Yet the spread would deliver north of 20% 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.