Call Options Or Put Options On Baidu (BIDU)?

| December 12, 2012 | 0 Comments

BIDU OptionsBaidu (BIDU) is the largest internet search engine in China.  They dominate the market with 80% of the China’s total internet searches performed on their website.

BIDU currently trades for $95.60 per share.  The shares are down 38% from the 52-week high of $154.15.  However, the shares have rallied 11% after reaching a 52-week low of $85.96 last week. 

Is this an opportunity to buy call options on BIDU as they make the transition to mobile?  Or should you buy put options on BIDU as the SEC investigation of Chinese accounting fraud heats up?

The bulls make a convincing argument…

BIDU has a dominant position in the Chinese internet search market with 80% of all internet searches.   In other words, they’re China’s version of Google (GOOG). 

And just like Google, Baidu’s dominance of search is a tough nut for the competition to crack.  Yet, investors have been worried that competition will cut into BIDU’s growth.

This fear seems to be overblown.  The competition is gaining ground on BIDU at the fringes of the Chinese market but BIDU dominates the urban population centers in China.

In fact, the biggest risk to BIDU doesn’t come from competition.  It comes from the transition to and ability to monetize mobile internet. 

Luckily, BIDU doesn’t have to reinvent the wheel in order to make mobile internet a profitable venture.  They’re simply following Google’s game plan for monetizing mobile in the US.

That’s right, BIDU is rolling out their first smartphone, the LePhone A586.  The new phone is being made in a partnership with Chinese hardware giant Lenovo and will use Google’s Android operating system.

The decision to use the Android OS may seem unusual.  But it’s actually a smart move by BIDU.  Android OS dominates the Chinese smartphone market.  A whopping 90% of all smartphones in China use Android.

So, BIDU is simply giving their customers what they want and know. 

In short, the combination of a dominate search engine and the dominant smartphone platform should give BIDU all the leverage they need to take over the coveted mobile search market.

What’s more, after a 40% decline in BIDU’s share price, the stock is downright cheap at just 15x next year’s projected earnings.  The cheap valuation and solid fundamentals should lead to a strong performance in the weeks ahead.

But the bears have a compelling case as well… 

The case for BIDU’s dominance of the Chinese search market isn’t the problem.  The bigger question about BIDU’s stock performance comes from regulatory concerns.

As you may know, the SEC has been investigating accounting fraud in Chinese companies for months.  And the investigation is reaching a boiling point.

The SEC wants the Chinese affiliates of the five major accounting firms to produce audit documents on nine Chinese companies suspected of accounting fraud.

The problem is Chinese laws consider audit documents to be state secrets.  So they can’t give the SEC the documents without the consent of the Chinese regulators.  But so far, the Chinese Securities Regulatory Commission has refused to give the accounting firms permission to release the documents to the SEC.

If the accounting firms don’t get permission soon, they could lose their licenses.  And without audited financials from a licensed auditor, the Chinese stocks can’t trade on US stock exchanges.

And if the accounting firms hand over the paperwork the SEC has requested without permission, they’ll violate Chinese law.  And likely be banned from operating in China… or worse.

Clearly, it’s an ugly situation.  And it’s one that will likely get worse before it gets better.

Until the regulatory spat between the US and China is resolved, it will create headwinds for Chinese stocks trading on US exchanges.  And will likely send shares of BIDU sharply lower in the weeks ahead.  

If you think the bulls are right, take a look at buying the BIDU March 2013 $110.00 calls for around $3.15.

If you think the bears are right, take a look at buying the BIDU March 2013 $82.50 puts for around $2.77.

Good Investing,

Corey Williams

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Category: Call Or Put Options?

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.