To The Moon

$PDD Holdings Inc(PDD)$ released its Q2 earnings report this week, showing an 86% year-over-year revenue increase, getting closer to the $100 billion mark. However, this growth fell short of market expectations, and online market service revenue also underperformed.

The real shocker came during the conference call when management hinted at worsening competition:

“Our operations [have] also become increasingly affected by nonbusiness factors. And meanwhile, the competition we face is growing stronger. Competition is here to stay and is expected to intensify in our industry.These factors combined will inevitably cause fluctuations to our business. As shown in this quarter’s results, high revenue growth is not sustainable, and a downward trend in profitability inevitable. Capital repurchases or dividends are not appropriate at this time, and we see no need for them in the foreseeable future.”

These comments sent the market into a tailspin, and Pinduoduo's stock plummeted. Following the earnings call, Morgan Stanley thought the comments on long-term profitability were too negative; Goldman Sachs remained optimistic about Pinduoduo’s long-term growth, and Bernstein saw the healthy, sustainable growth as a positive sign.

Citigroup noted that management's statements seemed contradictory, possibly signaling a “low-key” approach to managing competition and investor expectations. With limited investor communication, a lack of operational metrics, and cautious forward guidance, the stock might stay volatile until performance exceeds expectations.

Pinduoduo Options Activity

After the stock crash, investors started positioning with options. Recently, a large number of put options were sold for Pinduoduo, set to expire on October 18, 2024, about 50 days away. This transaction involved 737 contracts with a strike price of $80, and the total premium received was $78,100.

Given the drop, a Short Put strategy to buy the dip looks promising. Besides selling puts, investors might consider a diagonal spread to bet on Pinduoduo's recovery.

What is a Diagonal Spread?

A diagonal spread involves using options with different strike prices and expiration dates to create a spread. In this strategy, the long leg typically has a longer duration than the short leg. Diagonal spreads include both diagonal bull spreads and diagonal bear spreads.

A diagonal bull spread is similar to a bull call spread but with an added twist. The key difference is that the two options involved have different expiration dates. In this strategy, you buy a longer-dated call option with a lower strike price and sell a shorter-dated call option with a higher strike price. The quantity of the bought and sold call options remains the same.

Example of a Diagonal Spread for $PDD Holdings Inc(PDD)$

Suppose you’re bullish on Pinduoduo over the next month. You could buy a call option expiring on September 27, 2024, to establish your long leg. This option would cost $385 at the latest price.

After setting up your long leg, you can create a short leg with a shorter duration.

For instance, you could sell a call option with a $104 strike price and an expiration date of September 6, 2024, collecting a premium of $25.

If the sold call option expires worthless, you’d make a $25 profit. Given the $385 cost of the long leg, this represents about 6.4%. Since you can set up the short leg weekly, you might sell the short call options up to four times over the remaining 30 days of the long leg. Successfully collecting premiums from these sales can significantly reduce the cost of the long call option.

Compared to simply buying a call option, a diagonal spread provides extra premium income, which lowers the net premium expense and shifts the breakeven point to the left, improving the win rate. Moreover, you can control the strike prices and timing of the short legs, allowing you to manage risk more effectively. Essentially, a diagonal spread is a low-cost way to buy call options and is worth considering for investors.