The Equity bulls have been in complete control for months. But the bears recently succeeded in beating up on Baidu Inc (ADR) (NASDAQ:BIDU) stock. It fell 15% since its high in October. But there is a difference between bearish price action and a bearish set up. As long as the macroeconomic thesis remains as it is now, investors will buy the dips including BIDU stock.
So today, I want to take advantage of the sale and set a bullish trade that would generate income from Baidu stock into January.
It might not be all smooth sailing. Technically, I recognize that BIDU stock may have just started a measured move lower that could eventually target $210-per-share. Although it’s not a forecast, it is a possibility for which I have to make room.
In addition to the technical vulnerability, Baidu stock may have come too far too fast. Year-to-date, it’s still up 40%, so there is plenty of room for dips. But given its growth and fundamentals, the stock ramp is justified.
Besides, the October correction shook off the weak hands and deflated much of the 2017 froth. So if the markets in general don’t fall apart, BIDU stock should stabilize into year-end. And therein lies my opportunity.
No, I won’t buy the stock and hope for a rally. Instead, I will sell downside risk below proven support. If it holds, then I would create income with no out-of-pocket expense.
BIDU is a momentum stock so it moves fast. Using options to generate income allows me to leave a buffer zone. This way I don’t need to be surgically accurate with my entry points.
Also, the fundamentals on BIDU are attractive. Even though it is a growth stock, it’s not bloated. It trades with a 32 price-to-earnings ratio, which is inline with that of Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB), so it’s in good company there.
The experts on Wall Street agree with me that BIDU stock is worth the investment. It is now trading 12% below the average price target, so in theory there should be plenty of upside left in the stock.
Nevertheless, I will not need it to profit. In fact, the stock can fall another 10% and I can still retain my maximum profit.
The Bet: Sell the BIDU Jan 2018 $202.5 put for $1.10. This is a bullish trade that does not require a rally to profit. Here, I have an 90% theoretical chance of success, but I would accrue losses below $201.40.
Selling naked puts carries big risk, especially for a stock that is over $200-per-share and as volatile as this. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell the BIDU Jan 2018 $202.50/$200 credit put spread, which would deliver over 10% in yield, but with much smaller risk. Both set ups have about the same odds of success and neither require a rally to win.
Ultimately, 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.