Yelp Inc (NYSE:YELP) stock fell 5% yesterday at a time when the stock markets in general were making new all-time highs. We had high-flying companies breaking stock price records, so it’s disappointing when the one stock falls on such a bullish day.
Nevertheless, this doesn’t mean that it’s game over for the YELP bulls. In fact, it presents an opportunity when others are nervous about one stock inside a bullish environment. Consider that the price drop came after a downgrade from KeyBanc Capital Markets. Their concerns were mild in nature, not announcing impending doom. A sector-perform rating just means that it won’t be a shooting star.
For the past 10 months, Yelp stock has been trading inside a solid range. The positive side of that is the fact that it’s establishing a well-consolidated area that it could use as a base for higher forward prices. However this comes at a price. Constantly testing the bottom end of the range also creates a liability.
If the floorboard breaks, the bears then overcome the bulls and overshoot lower. In this case, if YELP stock loses the $40 per share area, then it could head straight to $38. Below that is the opportunity to fill the open gap from last August’s earnings spike.
So going forward, unless the bulls are able to hold support, then there are much lower prices in store for Yelp.
This is a scary scenario but not a forecast. This is merely one possibility out of many. You’d be surprised to see that I am sharing a bullish trade today on Yelp stock even after noting all the potential pitfalls. Because I use options to sell downside risk into this potential fear scenarios so I can generate income with no money out of pocket.
I am a conservative investor, so I consider this a speculative trade inside a fundamental portfolio. Using Yelp options instead of buying the shares outright allows me the opportunity to set a sizable buffer between current price and my level of risk.
Fundamentally Yelp is not cheap. It sells at a 24 price-to-earnings ratio. Compare this to, say, Apple Inc. (NASDAQ:AAPL) which has a price-to-earnings ratio of 18. Luckily, YELP stock’s price-to-book is 3 so it won’t be a massive financial mistake if I own the stock especially if at a big discount from $42 per share and that is important to this trade setup.
I sell downside risk into what others fear and let time do the rest. So I don’t even need a rally to profit. As long as price stays above my strike I retain maximum gains.
YELP Stock Trade Ideas
The Bet: Sell the YELP Nov $32 put and collect $1.10 per contract to open. Here I have a 85% theoretical chances that price will stay above my level. Else, I will accrue losses below $30.90.
Selling naked puts carries big risk, especially for a stock as frothy as YELP. For those who want to mitigate it, they can sell a spread instead.
The Alternate Bet: Sell the YELP Nov $33/$31 credit put spread where I have about the same odds of winning but with much smaller risk. Yet the spread would yield 15% if successful.
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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.