Name That Trade – $BIDU: Long Volatility Looks Like a Good Du

by Enis August 14, 2014 11:48 am • Commentary

We highlighted some interesting call options activity in BIDU in this morning’s TMO post:

BIDU – BIDU has held up well after a breakout in July.  Saw some call buying yesterday – trader pays 0.41 for 5,000 of the Aug16th 225 calls to open with stock 218.31.  Over 12k traded on the session at an average price of 0.38.  BIDU’s high after earnings is $229.60.  

The bizarre aspect of this trade is that the buyer bought a 2-day option, expiring tomorrow, with a break-even price of $225.41 that was more than 3% higher than where BIDU was at the trade’s initiation.  That’s quite an aggressive bet for any stock, even a fast mover like BIDU.

In any case, BIDU has had quite a run over the past 4 months, rallying nearly 50% in that time:

BIDU weekly chart, Courtesy of Bloomberg
BIDU weekly chart, Courtesy of Bloomberg

The stock’s breakout to a new all-time high was cemented by the stellar earnings report, which showed the continuation of the company’s shift to mobile.  GS Research summarized the highlights of the report as follows:

Mobile revenues exceeded 30% of Baidu’s total revenues in 2Q. Cost-per-click continues to rise, but remains at discounted levels relative to desktop, indicating further potential for pricing increases. The mobile search service recorded over 500mn monthly active users in June. On the back end, Baidu is (a) innovating deep learning technologies (e.g., set up a research center in California), which it expects to enhance the relevance between organic results and ad display, yielding better click-through metrics and (b) improving content quality by having vertical partners, such as Autohome and Bitauto, populate rich content to Baidu’s result page. A large number of mobile advertisers are adopting click-to-action solutions, which tie query to download and call activities to enhance marketers’ ROI.

BIDU’s EPS beat was in large part due to lower-than-expected marketing spend.  That in itself is a reflection of BIDU’s efficiency in attracting new users as it grows and improves its wide array of customer offerings.  The company is executing well in the highly competitive Chinese internet space.  

Most surprising to me is that BIDU implied volatility is still near a 2 year low:

[caption id="attachment_44192" align="alignnone" width="600"]30 day implied volatility in BIDU, Courtesy of Bloomberg 30 day implied volatility in BIDU, Courtesy of Bloomberg[/caption]

While the stock at a new high means that each dollar move means less in percentage terms (and can be one reason for implied volatility to decline as a stock rises), BIDU at a new all-time high is a different situation in my view since it is a stock that is popular with the momentum crowd.  In addition, BIDU is an impressive story stock, which also attracts speculative interest.  With no technical resistance above, the potential for volatility seems higher than it normally would be, but options market makers obviously disagree with me.

Finally, the Alibaba IPO in September could be a cause for volatility in the Chinese internet sector as a whole. The overall demand for the IPO, as well as the potential for fund managers to prepare their portfolios for the large offering could both be factors in moving BIDU and its peers.

While I don’t plan on a new trade in BIDU, it is somewhat tempting to take a small nibble at the Oct 200/240 strangle for around $8.85 given the low implied volatility.  The break-evens on that trade don’t look exceptional, but 2 months is plenty of time for a stock like BIDU.  I’m not going to enter any trades on BIDU, but for those with a view or a position, options pricing looks quite cheap.