Brace yourself: This one is high-risk, high-reward.
This week we’re looking at a 2-week to expiration earnings trade in Pinduoduo. This is a textbook bullish call spread against almost no open interest. That means whoever bought these is opening up a brand new position, expecting PDD shares to move meaningfully into earnings.
That means a lot considering Pinduoduo is down heavy today. This buyer bought these spreads with Pinduoduo down -3.8%, at $63.90. It’s even lower since then, currently trading at $62.71 as of $10:53AM EST. That said, we saw a similar buyer on May 9th with PDD at $60.40 buying up a very similar position — so it’s highly possible that this is a double-down dip buy.
That’s right — for those of you who felt uncomfortable buying our KRE calls (which were bought at $36, rallied higher immediately after we sent it out, and became profitable the very next day) — get ready to white-knuckle it once again. Let’s be clear: This is a fast-moving, high-beta stock in a sensitive sector, going into earnings. Nothing about this is safe.
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A few quick facts:
- This is a call spread — call spreads are a little more conservative than just buying a call — but you can do that too, if you like. This trader is probably trying to negate some of the potential IV crush and theta decay by using a spread instead of a straight call.
- To enter this particular call spread, you would find the June 2nd, 2023 call options, opting to buy the $69-strike calls, and simultaneously sell the $74-strike calls against it.
- The maximum value of this spread is achieved if, on June 2nd, PDD is trading at least as high as $74 per share — but just like with call options, this spread would likely gain value if PDD made a meaningful move higher before that.
- The max value of this spread is $5.00 ($500) — the current value of these spreads is exactly $0.95 ($95) as of 10:53AM, EST — About $0.22 lower than this buyer paid.
- That means this spread offers over 400% returns if PDD rallies.
- With earnings on May 26th, promising consumer data could lead this explosive name higher (particularly in China, where the reopening is well-underway and the “pent-up demand” narrative is still intact).
- In general, Pinduoduo has a habit of making very large moves in both directions — another reason why mitigating some risk with a call spread isn’t such a bad idea.
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As always, our two favorite risk management tactics are AJ Monte’s 1% rule, and Jon Najarian’s Half-or-Double rule of thumb. Those are:
AJ Monte’s 1% Rule: Try to use no more than 1% of your portfolio to take on option positions. If this position is already more than 1% of your portfolio, and you would still like to enter, consider just grabbing one.
Jon Najarian’s Risk Rule (Half or Double): If an option position gets cut in half, cut and run. If an option position doubles, take your profit and either roll to a cheaper position, or move onto the next trade with your newfound gains. For this position, that would mean you might consider adjusting your trade when it reaches roughly $2.00 per contract. That could mean you sell outright, or even roll the long-leg (the $69-strike call) up to, say, the $70 or $71-strike.
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