Last week the stock market suffered from a crisis of sentiment. Investors are now nervous about the rising bond yields. The fear is that as they rise, the opportunity in stock diminishes.
The Chinese stocks have been under pressure for a while. This is a by-product of the tariff war between China and the United States.
On Monday, the Chinese stock market fell 4% in spite of a liquidity injection from the government. The Chinese currency fell and the u.s. dollar spiked, thereby adding more selling pressures on stocks.
Baidu (NASDAQ:BIDU) stock has been in a slump for months. Year-to-date it’s down 15% while the Nasdaq Invesco Trust (NASDAQ:QQQ) is up 13% for the same period.
But this is not to the fault of Baidu fundamentals. The China Large Cap ETF (NYSE:FXI) is also down 13% in 2018.
Baidu stock is relatively cheap, selling at a 19 price to earnings ratio yet this is a growth company still. To put it into perspective it sells almost three times cheaper than Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).
That alone is not enough to buy the shares and hope for a rally, especially when the crisis on sentiment it is still ongoing. So I don’t risk $202 per share to buy the BIDU stock and hope it rallies so I can profit. Instead I use options in order to set a bullish position to try to catch the knife while leaving plenty of room for error.
Since BIDU stock is not bloated, I don’t mind owning it at a deeper discount from current price. I am confident that I will be able to profit from it in the long run.
Size matters, and when there is a falling machete that I’m trying to catch while markets are nervous, I always start smaller than I really want the position to be. In other words I takes half the position or less to start and then add to it as more information becomes available.
Technically, BIDU should be coming into a longer-term pivot zone. These tend to be supportive as they create congestion. But if they fail they then can start another leg lower. There should be support around $195, $160 and $130 per share.
BIDU Stock Trade Idea
The Trade: Sell the BIDU Jan $145 naked put. This is a bullish trade where I collect $1.50 to open. Here I have a 85% theoretical chance of success. But if price falls below my strike then I accrue losses below $143.50.
Selling naked puts carries big risk especially for a momentum stock like BIDU. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the BIDU Jan $150/$145 credit put spread, where I have about the same odds of winning but with much smaller risk. Yet the spread would yield 10% 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.