Last week, I told traders to beware of one of the biggest market disconnects in history.
While earnings for S&P 500 have declined for six straight quarters — the worst stretch in market history with the exception of the 2007-2009 recession — stock prices are hitting new all-time highs. It makes absolutely no sense!
This situation is cause for a bear market. At minimum, I’m looking for a near-term drop in stocks.
This doesn’t mean you need to exit the markets en masse, though. As I mentioned last week, there are tools that can be used to combat volatility and the market insanity.
That is because you can profit whether a stock — or index — goes up, down or sideways.
It’s called a bear put spread, and while it takes a bit more work on your part, I can guarantee it will be well worth the effort.
Last week, I explained the ins and outs of the strategy. If you missed that article, I suggest you read it now to familiarize yourself with how bear put spreads work.
Today, I’m going show you how we can make 20.7% in 22 days or less if shares of online travel company TripAdvisor (NASDAQ: TRIP) fall, stay flat or even move higher…
A Pricey Stock in a Competitive Market
TripAdvisor operates 25 websites that collect advice and reviews from millions of travelers to help users plan and book vacations. The company receives fees based on bookings and also earns revenue from advertisements.
TripAdvisor has struggled over the past year. The company’s first-quarter earnings report showed continuing weakness, with revenues falling 3% and net income plummeting more than 50% year over year.
Stiff competition in the already crowded online travel space could be about to get even stiffer. Alphabet (NASDAQ: GOOGL) recently joined the online travel business, allowing users to book hotels and vacations directly through the Google search engine, and Facebook (NASDAQ: FB) is expected to follow in its footsteps.
TRIP faces a number of additional fundamental challenges, as well, including its valuation. The stock is trading at 63 times trailing earnings and 31 times forward earnings (versus the S&P 500′s forward P/E ratio of 17). Shares are also trading above the consensus price target, which is rare, as this is supposed to represent where analysts believe the stock will trade 12 months from now.
For the cherry on top, my earnings prediction models are showing a high likelihood of a weak Q2 report when the company reports in early August.
But we don’t need TRIP to nosedive for us to make money. As long as shares stay below $75 through August expiration, we stand to make 20.7%.
Make 20.7% if TRIP Stays Below $75
Currently, TRIP is trading around $71. I recommend buying (to open) a bear put spread on TRIP for a net debit of $4.10.
This spread will use two separate put trades:
For our long put, buy (to open) TRIP Aug 80 Puts.
For our short put, sell (to open) TRIP Aug 75 Puts.
Your broker should allow you to execute both trades with one spread order.
Remember, for a bear put spread, you will always trade the same number of long and short puts with the same expiration month. These options expire on Aug. 19.
Each spread you buy will have a net cost around $410 (assuming you enter the trade at the “buy under” price). Because each contract controls 100 shares of the underlying security, we multiply the $4.10 net debit price times 100.
This trade breaks even if shares rise to $75.90 (long put strike price of $80 – spread cost of $4.10), about 7% above current prices.
The goal here is for TRIP to be below $75 when our options expire on Aug. 19.
If TRIP is below $75 on Aug. 19, the spread will achieve its maximum value of $5 (long put strike price of $80 – short put strike price of $75). However, for this trade, we’re going to set our exit target below the spread’s maximum value.
Once you’ve bought the bear put spread, immediately place a GTC limit order to close the entire spread for a net credit of $4.95 (using a “sell to close” order). If the spread hits our target price, we’ll generate a 20.7% gain in 22 days, or 344% annualized.
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Source: Profitable Trading