Max Grigoryev
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Max Grigoryev in Fundamentality,

Low-risk opportunity to earn 7% on YELP

Yelp is going to report its earnings today after the closing bell. After the previous earnings the stock lost almost 12%, but over the last three months the stock grew up more than 35%.

No worries if you missed such move, because investing in Yelp stock without hedging is too risky. Moreover, as far as the volatility is so high for the stock, I assume that it's the right time to work out a strategy that will handle such volatility. 

What we can do in this case: I had several posts about buying the ITM options and some traders told that the execution of such strategies is difficult for some of them, that's why instead of selling the strangle, I'd better sell the straddle with $21.5 strike price. The initial outlay and estimated returns will be the following:

Both call and put options right now will bring you $1.35 put option and $1.45 call option, moreover, you need to buy 100 YELP shares. As we can see the breakeven price is around $20.14 and we still have short put and long stock, so we definitely need to hedge both of them. We can do it by buying two put options with $20.5 strike price and pay for it around $2 for both put options. As a result we will have the $0.8 premium on the table.

You'll have several scenarios:

  • The stock goes higher than $21.5 and you will:
    • Keep the premium $2.8 per share ($280),
    • Earn on long stock (if the stock goes to $23, for example, you'll earn $1.65 per share, $165 in total),
    • Cover your short call (if the stock goes to $23, you'll lose $1.5 per share, $150 in total),
    • Lose long puts (75c per share, 2 put options, $150 in total),
    • Your total return could be over than 7% or $145, if the stock goes to $23, for example
  • The stock stays between $20.5 and $21 (roughly) and you will:
    • Keep the premium $2.8 per share ($280),
    • Lose on long stock (if the stock goes to $20.7 for example, you lose 65c per share, $65 in total),
    • Cover your short put (if the stock goes to $20.7, you lose 80c per share, $80 in total),
    • Lose your long puts ($1 per share, 2 put options, $200 in total).
    • Your maximum loss will be around $65 in this tiny range (the stock should go down from 2% to 4%)
  • The stock goes below $20.5 and you will:
    • Keep the premium $2.8 per share ($280),
    • Lose on long stock (if the stock goes to $19 for example, you lose $2.35 per share, $235 in total),
    • Cover your short put (if the stock goes to $19, you lose $2.5 per share, $250 in total),
    • Earn on your long puts ($1.5 per share, 2 put options, $300 in total).
    • Your return will be around $95, or over 4.4%

So basically, as you can see from the scenarios, you have a certain risk that the stock will go down for 2%-3%-4%, but when it goes down 1% or more than 4%, or even goes up, you'll earn some money. Taking into consideration a high volatility of the stock, this strategy is worth at least checking. 

You can also decrease the risk, but also decrease your return by buying put options with $21 strike instead of $20.5.

Let me know what you think about the strategy in the comments.