U.S. Markets close in 5 hrs 10 mins

iQIYI: Don’t Believe the Scary Picture Show in IQ Stock

Chris Tyler

It has been hailed as China’s Netflix (NASDAQ:NFLX). But if iQIYI (NASDAQ:IQ) is anything like one of the greatest investmets of recent years, investors would be wise to not underestimate bearish narratives along the way and to prepare for battle using a well-positioned bull call spread in IQ stock. Let me explain.

I’ve said it before and I don’t mind saying it again, an IPO — or initial public offering — can be tricky business. But don’t let that dissuade you either, especially if it’s the recent IQ IPO. The Netflix wannabee has some solid DNA being a spin-off from China-based tech giant Baidu (NASDAQ:BIDU). What’s more, IQ’s massive sales of nearly $780 million have generated roughly 20% of BIDU stock’s revenues. Nice, right?

Of course, it’s not a perfect story-line for IQ stock. There’s competition from the likes of other Chinese powerhouses Tencent (OTCMKTS:TCEHY) and Alibaba (NYSE:BABA). However, much like Netflix, iQiyi enjoys solid market share to the tune of 28% in China and boasts active monthly users in excess of 500 million.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Another problem? IQ stock has also yet to show a profit. That’s bound to rattle some value players. But as most seasoned investors are aware, a lack of profits at this stage in the game isn’t a deal-breaker for becoming a dominant brand and generating serious returns. Netflix is a poster child of that phenomenon. But as NFLX stock can also attest, the road to investing fame and glory can be filled with episodes of tragedy and mayhem along the way.

IQ Stock Daily Chart

 

Looking at the daily chart and the limited price history of IQ stock, shares are in the midst of their first correction since establishing an aggressive uptrend back in May. The pullback of 31% is also far from unusual for early stage growth stocks like iQiyi and comes with the territory for investors keen on buying into the next Netflix.

What’s next? While the price reaction off IQ’s recent highs should be taken in stride, shares are now in the ballpark of where investors should begin to support iQiyi. The absence of buy-side interest could point to a longer and more drawn out decline where China’s so-called Netflix may need to go through similar and sometimes painful growing pains, before and if the bullish narrative unfolds.

IQ Stock Bullish Combined Spread Strategy

Correctly picking how deep and long a correction will be is tricky business. But the options market in IQ stock can help minimize risk and increase your chance for a more successful outcome.

After reviewing iQuiyi’s options, an out-of-the-money bull call spread looks appropriate given what has been discussed. With shares at $36.29, one favored vertical is the Sep $40/$55 call spread for $3.

With this spread on IQ stock, an investor cuts down on Greek risks associated with a straight long call purchase. At the same time, he or she is able to guarantee their downside exposure is limited to 8% in the event a fairly run-of-the-mill correction turns into a bonafide bear market.

By using the September contract, this strategy on IQ also has an embedded earnings catalyst with enough calendar time for a favorable reaction to play out and move the spread in-the-money.

The one compromise is IQ stock does need to move up by about 10% on an expiration basis before the position begins to build intrinsic value. However, if a trader has a bullish outlook on the IQ IPO, this spread is well-placed for a reaffirmation of the uptrend and built to capitalize on that outcome.

Investment accounts under Christopher Tyler’s management do not currently own positions in any securities mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT and StockTwits.

More From InvestorPlace

Compare Brokers

The post iQIYI: Don’t Believe the Scary Picture Show in IQ Stock appeared first on InvestorPlace.