The market has had a great run in recent months for those with a lot of bullish exposure. But for those expecting a little reversion to the mean, adding some bearish option trades can be a good way to hedge some of that exposure. PDD stock set up a candidate with a sharp drop Monday that breached the 50-day moving average line. A bear put spread can add some exposure for downside moves while limiting the capital outlay.
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Going Bearish On PDD Stock
PDD Holdings (PDD) tumbled over 8% Monday on reports that the popularity of its Temu app might be “cresting” in the U.S. For a stock that has been nicely contained by its 50-day line, it’s an important change in character. That change in character makes PDD stock a nice candidate for a bearish trade.
According to IBD Stock Checkup, PDD stock is ranked No. 1 in its group and has a perfect Composite Rating of 99, an EPS Rating of 74 and a Relative Strength Rating of 93. Not normally the type of ratings you would consider for a bearish trade. But the severe break of support on the chart is what we’re focusing on here.
PDD stock saw an 18% gap-up on Nov. 28 and it is now in danger of getting that open space filled down to 120. It still has over a 25% cushion above its 200-day moving average line. But after its recent flat action, you normally expect a break to one side to establish a new trend. Right now, PDD stock looks like it’s choosing the downside.
Setting Up A Bear Put Spread
To set up a bear put spread on PDD stock, we’ll start by buying a put at 120 with a June 21 expiration. To help reduce the cost of the put, we’ll sell a put at 115 with the same expiration. The net cost of the trade ends up being around $2 per spread, or $200. This is also the most you can lose on the trade.
As for profit, taking the difference of the strikes and subtracting the cost of the spread, you have a potential maximum gain of $300. That’s not a bad reward for the risk. It also sets up a break-even price of 118. That’s the long strike minus the cost of the spread.
A close below 115 for PDD stock at expiration achieves the maximum profit. But you don’t necessarily have to wait that long.
An early move to the downside could let you capture a bulk of the profits without holding for the long duration. Remember, since we are reducing our cost by selling the 115 put, we are also reducing the gain we can achieve.
If PDD stock finishes above 120 at expiration, the spread expires worthless and you lose your full cost of $200.
As this is a bearish position, traders who think PDD stock could move higher from here should not enter this trade.
It’s important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
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