Name That Trade – $YY Tell ‘Em That It’s Human Nature

by Dan March 5, 2015 11:29 am • Commentary

Yesterday I found myself doing some work on Chinese online travel company (CTRP) that led to a trade (New Trade – $CTRP: Trip and Fall?) and this morning writing (MorningWord 3/5/15: Bull in a China Shop)on Alibaba (BABA) and Baidu (BIDU) as I am intrigued by both from a sentiment standpoint.  For some reason I have U.S. listed Chinese internet stocks on the brain at the moment looking at YY Inc (YY) a social media platform in China.

Event: YY reports Q4 results tonight, the options market is implying about an 8% one day move, which is well above the 4 qtr avg of about 4%, which coincides with the long term average.

Price Action / Technicals:  The last time I looked at the stock was early September, when the stock was ~$93 breaking out to new 52 week highs. Here is what I had to say on Sept 4th:

The chart over the last couple years is nothing short of breathtaking, up nearly 800% in that time period, never going below the closing tick from exactly 2 years ago, and now trading at new all time highs!

YY 1yr chart from Bloomberg

I am gonna keep this real simple.  This is not normal price action, and I am not so stupid to start speaking of such things as bubbles, but it seems that anticipation into the Alibaba deal is causing some irrational exuberance once again.   $10 to $90 to $50 and back to $90… ummmm all yours, too rich for my blood.

Well the stock has since declined 45% from the highs in early September, and is now down 15% on the year.  Looking at the chart with a one year time frame, the stock looks very oversold and is potentially setting up to make an epic double bottom:

YY 1yr chart from Bloomberg
YY 1yr chart from Bloomberg

But when it comes to charting, beauty is definitely in the eye of the beholder, as a quick gander of the 5 year charts shows the Triangle of Death, with the stock threatening to break long term support, with little support below for 15 to 20%:

YY 5yr chart from Bloomberg
YY 5yr chart from Bloomberg

Sentiment: It appears that Wall Street analysts got a bit off sides after the sharp decline since the fall, with the average price target of about $98, and ratings of 15 Buys, 2 Holds and NO Sells.  Short interest is only about 5% of the float.

Expectations / Valuation:  Current consensus expects eps growth of 36% in 2015, and sales growth of 50% (from $296 million to about $590 million). With the stock nearly cut in half, and those estimates still intact, the stock looks fairly cheap all of the sudden, trading at only 13.5x expected earnings and 3.5x expected sales.  The real question to be answered is whether or not 2015 estimates are achievable.

Options Open Interest and Volatility Snapshot:  there is a total of 66,000 open interest, amazingly split between 33,000 calls and puts.  The largest strike of open interest by a long shot is 10,500 of the Jan16 25 puts, which are basically worthless, then 2500 March 50 puts, and 2500 Jan16 80 calls.

Thirty day at the money implied vol (blue line) has approached levels of where it has been prior to the last few earnings reports, off of 52 week lows last month, while the spread  between realized vol (movement of the stock) and IV seems a bit stretched. Options are expensive into the event:

YY 1yr chart of 30 day at the money IV vs Realized vol from Bloomberg
YY 1yr chart of 30 day at the money IV vs Realized vol from Bloomberg

MY VIEW: on a near term technical basis the stock looks oversold, and could be a great entry for those with a bullish outlook. On a longer term view the chart is at a very critical support level.  But that’s just one input. Valuation looks very reasonable if current estimates are doable. All that being said I have no idea what the current business environment is for social media platforms in China, assuming you take their guidance at face value.  Not that there’s is a huge take-away from BIDU’s Q1 guidance last month, but the company did offer a sales view below consensus as they deal with a mix shift from desktop to mobile searches which are monetized at lower rate than desktop searches. I assume this could be extrapolated a bit to a YouTube-like YY model. Lastly, without a directional view options prices seem very expensive, so as always into events, long premium strategies need to get a lot of things right to just break-even, like direction, timing and magnitude of the move.

Hypothetical Trades:

Bullish: The 5% bounce in the shares this morning make long entries a bit hard into the earnings event. But I think with the stock $53.90, the March 6th weekly 55/60 call spread for 1.25, 1/4 the width of the spread could be the way to play for a bounce back the breakdown level at $60.

Bearish: but for those who think a miss and a guide down could cause a quick re-test of the $50 support level, owning that strike could be the way to play.  Looking out to April, with the stock near $53.90, if you could get the 50/40 Put spread for about $2.50, or a 1/4 of the width of the spread that could be one way to play for continued weakness, I just don’t have the conviction at the moment.