$BIDU or Don’t?

by Dan May 2, 2016 3:11 pm • Commentary• Trade Ideas

On Friday, shares of Chinese search behemoth Baidu (BIDU) closed up 5% on the day (after being up 8%) as a result of the company’s Q1 results and better than expected revenue outlook.

Today BIDU is down 7.5% on the revelation that Chinese regulators are investigating the company following the death of a user, who wait for it, used BIDU’s search engine to search for a cancer treatment that ultimately failed, from Bloomberg:


Investigators are looking into BIDU’s vetting of advertisements that are accessible through their search engine.  While this sounds fairly ridiculous, and the stock is probably over-reacting to the most likely outcomes, it is nearly impossible to handicap what the worst case outcomes may be.

This is one of the weirdest charts you will find, two consecutive daily gaps in the opposite direction after a long consolidation:

[caption id="attachment_63318" align="aligncenter" width="600"]From Bloomberg YTD From Bloomberg[/caption]

Taking a longer term view, the stock has been in downtrend from its 2014 highs above $250, have just been rejected on Friday.  The stock looks poised to remain range bound below the series of lower lows, and what looks like two higher lows since mid last year:

[caption id="attachment_63319" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

While short dated options prices appear close to the low end of the 6 month range, the June 180 straddle (the call premium plus the put premium) is offered at about $18 (stock ref $180) or about 10% of the stock price. If you bought that, and thus the implied move between now and June 17th expiration, you would need a move above $198, or below $162, which has essentially been the two month range for the stock.

BIDU screens as cheap relative to expected growth, trading 27x 2016 eps that consensus has growing 30%, on 19% sales growth. BIDU trades 5x those expected sales vs GOOGL at 7x and FB at 13x.  The bull story, is that while mobile phone adoption in China may be saturated at close to 1 billion people, or about 87% of their population (per Statista), less than half use the mobile internet, and less than half use smartphones. SO, despite high mobile penetration, smartphone and mobile internet usage have a long way to go, and in rural areas these devices serve as the main device to access the internet. In other words, the whole accessing the internet thing is the huge growth opportunity for BIDU.

While I don’t have a position in the stock or the options, I find the situation pretty interesting, especially if the stock were to continue to sell off towards $160, the gap level from its Q4 earnings report in late February.

It appears that investors are scrambling for either short term protection, or playing for lower lows in the near term, as options volume is already 3x average daily, with puts outnumbering calls 2.5x to 1.  The most active options on the day are 22,600 of the July 180 puts, a strike that had no open interest before today.  The VWAP on this strike is about $11.30, implying  a break-even below $168.70.