Sky-high valuation or not, Zillow has been a major winner in 2014, up 64% year-to-date, even after declining nearly 20% from its late July high. That high was set after Zillow announced that it was buying its main online competitor, Trulia (full details in this WSJ article). The stock has remained in a long-term uptrend since its takeoff in late 2012:
Investors welcomed the Trulia deal in anticipation of potentially higher pricing for real estate and mortgage advertising after the merger. Zillow is certainly the market leader in real estate information, though the fact that it’s still primarily beholden to ads is a potential risk.
Tiger Global amassed 9% of the company’s shares in the first half of 2014, likely a major underlying bidder as the stock advanced to start the year. However, the stock is unchanged in the past 3 months, and the 50 day ma is downward sloping for the first time since late 2013:
The $120 is important support for Zillow, while the rising 200 day moving average is now around $107.
Zillow’s options pricing has historically been quite expensive, but it recently hit a 2 year low as the stock’s realized volatility declined:
The next earnings report is not until early November, with no catalysts in the interim, so options volumes have been light in the past month. With short interest still around 30% of the float, and the Trulia merger still pending, options prices might not stay low for long.
While I don’t have an interest in a new trade in Zillow given the high short interest and the overall resilience of the stock in 2014, I did want to lay out a couple of ideas for downside protection for those that are concerned that the deal might break, or just generally of the view that Zillow might be headed lower.
Since November expiration catches earnings, both of these trades are November expiration or later.
1) Z ($132) Buy the Nov 120 / 100 Put Spread for $4.60. This trade structure is straightforward, taking advantage of relatively low implied volatility, and provides support between the initial $120 support level, and the longer-term support level of $100, that was resistance from Sept 2013 to the spring of 2014. Those who don’t see upside above $160 could sell the Nov 160 call around $3.00 to further reduce the cost.
2) Z ($132) Buy the Feb 120 / 95 / 70 Put Butterfly for $4.90. This trade structure offers more time (and captures both the November and the February earnings reports) at a similar cost, but since it is a butterfly as opposed to a straight put spread, it will not appreciate as quickly on the downside and does not offer clean protection like the November put spread. This is more of a speculative position than a protection trade for a long holder. Moreover, this trade is also very time dependent, so not a good position for a purely short-term directional view, but it will hold its value better than a put spread if Zillow remains above $120 over the next few months.
Zillow’s options don’t trade frequently because bid/offer is wide and the high level of implied volatility makes long premium structures less appealing (and short premium structures are difficult to stomach given the stock’s volatility and headline risk). These two ideas are not terrific risk/reward, but better alternatives than most potential structures in the stock.