The Snap Inc (NYSE:SNAP) initial public offering stirred heated discussions. The stock burst onto the market with a double, but since then has since set lower highs and, entering Tuesday trade, had fallen below its IPO price. Today, I want to trade SNAP stock from the long side.
Click to Enlarge I won’t make the argument that Snapchat’s parent is a value grab here. So I won’t risk $16.50 to buy the shares without any room for error and merely hope that the stock rallies. Instead, I’m going to utilize a trade that will exploit the market’s extreme fears.
We can do that by trading around extreme valleys where prices aren’t likely to go.
To the risk of upsetting its fans, Snap’s management made a mistake by labeling themselves a “camera company.” Maybe that’s apt — their stock is more likely to eventually go by way of GoPro Inc (NASDAQ:GPRO) than Facebook Inc (NASDAQ:FB).
So if SNAP stock turns lower still, we don’t want to turn this into an investment.
The basis of my thesis is that I can temporarily own Snap shares. As a reward for my risk, I collect a premium at to open the trade. If the price stays above my strike, then I keep the entire amount as my maximum gain.
I am not required to hold my trade open through its expiration. I can close it at any time for partial gains or losses. This is important because I don’t like to overstay my welcome in trades.
I definitely don’t want to hold this through Snap’s next earnings report.
Falling knives are scariest when they appear to have no bottom. SNAP is in free fall, so today’s trade will be selling risk against elevated fears, and generating income in the process.
The advantage of selling puts below current prices rather than buying shares is that I can build myself a buffer zone so I don’t have to be as precise in my entries.
Case in point: When SNAP stock fell hard after its first earnings report as a publicly traded company, I caught that knife with a trade that delivered profits out of thin air. I sold puts and bought calls.
My thesis then was that those who missed the IPO would take advantage of the dip to get on board. I don’t have that same conviction now. Today, I am choosing a strike that includes an elevated level of guessing, which makes this a speculative trade.
How to Trade SNAP Stock Here
The bet (with emphasis on “bet”): Sell the Aug $13 put and collect 60 cents to open. Here I have an 80% theoretical chance of success. But if shares fall below my strike, I have to buy the stock and will accrue losses below $12.40. Still, I’m comfortable risking owning SNAP at an 18% discount from here.
However, if you don’t want to own shares, you’d be better off selling a spread instead of naked puts, where the risk is more finite.
The Alternative: Sell the Aug $13/$12 put spread, where I stand about the same theoretical odds of success but with less risk. Yet, if successful, the spread still yields 30% on risk.
Investing doesn’t come with guaranteed results, so I never risk more than I am willing to lose.
Learn how to generate income from options 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 on Twitter at @racernic and stocktwits at @racernic.
