Baidu Inc (ADR) (NASDAQ:BIDU) stock has had a choppy 12 months. It had two 20% rallies that completely priced back out. Now it’s in the process of giving back part of its most recent 15% run.
Baidu stock is a momentum trade. It moves fast, which means that I need to be surgical when buying the shares.
Using options makes the task of trading BIDU easier. There I can build room for error, which reduces the need to have great timing.
There are huge profits in catching one of BIDU’s upswings, but I compare this to swinging for the fences with every at-bat. It could yield fantastic results, but more often than not it’s a whiff.
I prefer delivering base hits with trades that have 90% theoretical certainty of success. I can do this but only with tickers that I trust. So they need to be fundamentally sound and with a real story that I can bank on.
Today, I want to create income from selling risk against levels that are not likely to come. I do have to note that the long term BIDU price range is tightening. This usually precedes a big move where direction is unknown. So I need to build a sizeable buffer that would survive that move against me should it come.
Fundamentally, BIDU is not cheap, but considering its growth it’s not outrageously expensive either. Expectations are also not too lofty. Most analysts rate it as a “hold.”
Most importantly, I can see proven support levels, and therein lies the opportunity.
BIDU Stock Options
The Trade: Sell BIDU Sept $145 puts for $1 per contract. Here I have a 90% theoretical chance that I will retain my maximum gains. But if price falls below my strike I will own the shares and suffer losses below $144.
Selling naked puts is not suited for all traders. It carries sizable risk especially on high ticket stocks like BIDU. So to mitigate the risk I could use spreads instead.
The Alternate: Sell BIDU $150/$145 credit put spread where I have about the same chance of success, but with more limited risk profile. Yet the spread still has a chance of yielding 10%. Compare this with risking $179 per share and without any room for error just to match the performance of the spread.
Normally, I would sell upside risk to balance my trade. But in this case, and since BIDU is a momentum stock, I will delay entry and may even completely opt out of it.
Given the size of the buffer and the time on the clock, I am confident that I can manage my risk against short-term price gyrations.
Trading options is risky business, so I only risk what 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.