PayPal Holdings Inc (NASDAQ:PYPL) has had a parabolic 12 months. It came into its earnings up 110% in a year, which is more than double that of the stock performance of Visa Inc (NYSE:V) or Mastercard Inc (NYSE:MA). Typically Wall Street investors reward growth so companies like PYPL and Square Inc (NYSE:SQ) tend to attract more bids.
But when things go wrong, the selling comes fast. And that is what is happening to PYPL stock today.
From a valuation basis, PYPL stock is not cheap. It has a price-to-earnings ratio of 66, which is double V and MA. Yet until this earnings report, investors did not care. This morning, the shares are down 11% and mostly on fears of forward expectations. There was news on the eBay Inc (NASDAQ:EBAY) front which could jeopardize a chunk of their business that comes from the bid site.
Though worrisome, I bet the time frame is flat enough that PYPL bullish thesis remains unscathed in the long run. PayPal revenues coming from EBAY have been in decline since the two separated in 2015. So for the next two years, the trend will continue and the transition won’t be a revenue cliff.
Technically, this dip in PayPal stock brings it into a prior contention zone. Those tend to create log jams which should translate into support.
When a stock rises as fast as this one did, catching it on corrections is scary to most investors. Buying it now and hoping for a bounce, although can be very rewarding, it is loaded with too much hopium. I don’t know when the selling will abate, so it’s more gambling than investing.
Today I do want to catch this falling knife, but I will not buy the shares in the open market. Instead, I will use PYPL options, where I can create a buffer zone between my risk level and current price. Meaning I can leave room for error so I don’t need the stock to flip on a dime.
My macroeconomic thesis is the equity bulls are still in control under the Trump trade context. So I structure my trades in PYPL with the assumption that we won’t have a severe market-wide correction.
PYPL Stock Trade Idea
The Bet: Sell the PYPL April $62.50 put. This is a bullish trade for which I collect 60 cents to open. I have a 85% certitude that I will retain maximum gains, but if the price falls below my strike then I own shares. I would then need to manage off my break-even point of $61.90.
Selling naked puts is daunting. Those who want to mitigate that risk can sell spreads instead.
The Alternate Bet: Sell the PYPL April $62.50/$60 bull put spread, which has about the same odds of winning and would yield 10% on risk. Compare this with risking $78 per share here and without any room for error expect a rally 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.
