Arcángel de Jesús Montoya
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Arcángel de Jesús Montoya in Money Trafficking,

Buy Baidu's Options Tomorrow Before Earnings

Baidu, Inc. (BIDU), a Chinese language Internet search provider that offers a Chinese language search platform on its Baidu.com Website, which enables users to find information online, including Webpages, news, images, documents and multimedia files, through links provided on its Website, is reporting earnings on Thursday, July 28, after market close:

(Source: TD Waterhouse)

As evident from the above, the company beat earnings estimates in 62% of time in the last eight quarters, underperforming in 38% of time, and has seen modest volatility in the market price of its stock over the last three months (mostly Brexit-related):

The market participants expect the following numbers over the next few quarters, including the upcoming one:

(Source: TD Waterhouse)

Note the wide deviation of expected financial results.

On the other hand, market data show that the August options are relatively cheap:

(Source: TD Waterhouse)

The monthly straddles (options with a strike price of $165.00) are worth around 7.8% of the current market price of the stock. Historically, the stock has been more volatile than that on a monthly basis over the last year:

(Source: Google Finance. Calculations by author)

As you can see, the stock has had a monthly standard deviation of 11.9% over the last 52 weeks, while the straddle expiring in a bit less than a month has an implied monthly volatility of around 10.7% (calculated based on 17 business days remaining until expiration), also including volatility from the earnings event this week. I therefore see signs of modest undervaluation in these options.

Investors can be interested in selling out-of-money options to partially finance the straddles. On the one hand, this will limit expected returns. On the other hand, this action will minimize losses in the event the stock does not move swiftly over the next three weeks.

What do you think of this trade?