Yahoo Finance Short Baidu Inc (ADR) (BIDU) Stock Without the Risk
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Baidu Inc (ADR) (NASDAQ:BIDU) is a momentum stock and it just proved it again this July. BIDU stock has had a rocket-ship rise, spiking over 25% in mere days this on bullish comments from management. But before you label me crazy for betting against such a meteoric rise, know that I will do so with zero out-of-pocket risk.
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Shorting a stock outright is very risky as I’d open myself up to unlimited risk. If I am wrong, my losses would accumulate for as long as the stock continues its rally. I use Baidu options to eliminate this risk. There, my exposure would be finite and I control my odds of success.
Even then, I know that many may think that I am committing financial suicide trying to short such beautiful momentum, but not when I will use BIDU’s own strength against it.
Although BIDU management team recently told us to reset their parameters higher and the stock responded in kind, today my bet is against the spike, not the fundamentals themselves. I believe that Wall Street traders are a fickle bunch and they will book profits quickly on such steep climbs.
Although this is not the same as dissing the company’s fundamentals but a bet against the recent price action, I still have beef with the valuation. I just don’t believe that BIDU stock deserves twice the valuation of Alphabet Inc (NASDAQ:GOOGL) and three times that of Apple inc. (NASDAQ:AAPL) especially when it runs worse margins and doesn’t pay a dividend.
My thesis is a pure bet that the stock could find sellers around the $230 per share highs and revert lower. But before you pin the crazy label on me for daring to oppose BIDU management’s enthusiasm, I will in fact use their bullishness to finance my bet. That’s right, I will short this stock with zero out-of-pocket expense.
I am not a fan of buying premium and hoping my bet plays out in my favor, especially when I am fighting a viscous bull. So I will offset my expense by selling downside risk against the value that now exists in the stock.
The Bearish Bet: Buy BIDU stock Sept $210/$200 debit put spread for $1.25 where this would be my maximum risk. If price falls through my spread then I stand to gain over $8.
To eliminate my expense, I will set a bullish trade to bring me potential income as long as I choose solid support below which I can sell puts. Technically, I see such a clear support zone around $160 per share.
The Bank: Sell BIDU $160 Jan 2018 put naked and collect $2 to open. Here I have a 90% chance of complete success.
The results of taking both trades is a net credit into my account today. Ideally I want BIDU stock to fall through my bearish debit put spread, but stabilize above the puts I sell through Jan 2018.
Since the pair trade will result in a net credit (as long as BIDU stays above $160) then any premium that I recapture from selling the debit put spread would be pure profit. So even if BIDU stays strongly above my bearish bet, I am already profitable and can add to it.
It is important to note that I will own BIDU stock if price falls below my sold puts, so I must be willing and able to own BIDU at that price. To leave this on a good note, my previous recent trades in BIDU, like this one, were easy bullish wins, so I come into today with profits in hand.
Investing is never guaranteed, so I never gamble more than I can afford 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.
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