In the summer of 2017, investors flocked into Baidu Inc (ADR) (NASDAQ:BIDU). BIDU stock rallied 40% in one quarter. Management told us then that business was great and that they would over-deliver on their promises. Wall Street listened and a buying frenzy ensued.
BIDU stock has fallen back from the highs, but in the process it set a tradable bounce level and therein lies my thesis today.
I want to generate income from the recent support. This is an uber-bullish stock market and the fundamentals support it. The dips, if and when they come, won’t be sustained. So it’s likely that any selloffs in BIDU stock will hold support.
This is a momentum stock; it moves fast so it’s hard to get the timing right. A few hours early or late makes a world of difference. So buying Baidu stock now and hoping for a rally is daunting. Instead, I use options where I can establish a moat around my trade. This way my thesis has a much higher odds of success.
Trading BIDU Stock
I don’t mind owning shares of BIDU and this is key to my strategy. I just would prefer to do it at a discount from here. My strategy pays me for the opportunity to buy the shares at a much cheaper price.
After the 2017 summer spike, BIDU stock has established a new plateau around $220. This served as a base for the rally to $270-per-share. This has also been support since then. This morning, Baidu stock is falling a bit and I will take the opportunity to sell premium against what others fear.
Fundamentally, BIDU is fairly priced relative to say Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB). So even if my thesis is broken, I won’t be overpaying for a bloated stock. I am confident that in today’s macroeconomic environment, I would be able to successfully own the shares at a 12% discount from here.
The bottom line is that the stock market is headed higher under these conditions. So BIDU dips are long entry opportunities. This one will end and buyers will step in.
The Trade: Sell the BIDU Feb 9 $225 put and collect $1 per contract to open. Here I have an 85% theoretical certainty, so that I retain maximum gains. Otherwise, I will own shares and accumulate losses below $224.
Selling naked puts carries big risk, especially for a $250 stock and as volatile as this. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the BIDU Feb 9 $227.50/$225 credit put spread. The spread has the same odds, but it would deliver a 15% yield on risk. Neither trade requires a rally to profit. In fact, the stock can fall an additional 12% and I could still retain maximum gains.
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.
