Chinese search sultan Baidu, Inc. (BIDU: sentiment, chart, options) will step into the earnings spotlight after the closing bell tomorrow, according to Thomson Reuters. While call volume has accelerated ahead of the event, digging deeper into the action indicates that not all of the activity has been bullishly oriented.
Late Friday morning, one option trader sold 100 out-of-the-money February 460 calls for $11.74 each. However, to help hedge his bets in the event of a short-term rally, the investor simultaneously bought an equal amount of deeper-out-of-the-money February 470 calls for $8.73 apiece. In other words, it appears one neutral-to-bearish bettor employed a bear call spread on BIDU for a net credit of $3.01 ($11.74 - $8.73).
By implementing the spread, the strategist is expecting the shares of BIDU to remain beneath the $460 level through options expiration on Friday, Feb. 19. In this best-case scenario, both the 460- and 470-strike calls will expire worthless, allowing the trader to pocket the $3.01 received at initiation – which represents the maximum potential reward on the play.
However, the investor could incur a hefty loss if the stock skyrockets beyond the $470 level before expiration. In this worst-case scenario, the cost to buy back the now-in-the-money February 460 call will be more than the intrinsic value of the in-the-money 470-strike call, resulting in a loss on the play. Nevertheless, the maximum potential risk is capped at $6.99 (difference between strikes – net credit).
In order to avoid a loss, the investor needs BIDU to finish no higher than breakeven at the $463.01 level (sold call strike + net credit) at expiration.
Technically speaking, the shares of BIDU have been on fire during the past year, more than tripling in value along the support of their 10-week and 20-week moving averages. Furthermore, the stock has been a broad-market standout lately, outpacing the S&P 500 Index (SPX) by 19% during the past 20 sessions. A stronger-than-anticipated earnings report tomorrow could help send the equity on its next leg higher – which could hamper the aforementioned spread strategist's chances of pocketing the initial net credit.
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