Pinduoduo Goes Parabolic

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About: Pinduoduo Inc. (PDD), Includes: BABA, JD
by: David Pinsen
Summary

Since its IPO in July of 2018, Chinese Pinduoduo has outperformed competitors Alibaba and JD.com, and Pinduoduo's shares have spiked more than 80% since July of 2019.

Now, Seeking Alpha contributor ALT Perspective argues Pinduoduo is at a crossroads strategically, while its shares trade at a valuation premium to its competitors.

In the event Pinduoduo declines significantly from here, I present ways cautious longs can limit their risk while staying long.

Pinduoduo welcomed to the Nasdaq last year. Photo credit: Reuters

Pinduoduo Goes Parabolic

Before Pinduoduo's (PDD) IPO last year, I noted that it presented a competitive challenge to Alibaba (BABA). In that article, I included this chart brought to my attention by Seeking Alpha contributor Rohit Chhatwal, which showed that Pinduoduo's number of daily active users had already surpassed those of JD.com (JD).

Since then, Pinduoduo has outperformed both Alibaba and JD.com.

Chart Data by YCharts

But it has gone parabolic since July, spiking more than 80%.

Chart Data by YCharts

Now, Seeking Alpha contributor ALT Perspective argues that Pinduoduo is at a crossroads: its shares are trading at higher valuations than those of its competitors Alibaba and JD.com, and its management has to decide whether to focus more on competing with BABA and JD in bigger cities or expanding its niche in rural parts of China. For cautious Pinduoduo bulls who want to stay long while strictly limiting their downside risk, we'll look at a couple of ways of doing so below.

Adding Downside Protection To PDD

For these two examples, I'll assume you have 1,000 shares of PDD and can tolerate a decline of 20% over the next several months, but not one larger than that. In both cases, I've circled the cost as a percentage of position value to distinguish it from the annualized cost as a percentage of position value.

Uncapped Upside, Positive Cost

As of Friday's close, these were the optimal, or least expensive, put options to hedge 1,000 shares of PDD against a greater-than-20% decline by mid-April.

Optimal hedge on PDD via Portfolio Armor.

The cost here was $3,700 or 10.58% of position value, calculated conservatively, using the ask price of the put options. In practice, you can often buy and sell options at some price between the bid and ask.

Capped Upside, Negative Cost

If you were willing to cap your possible upside at 20% between now and mid-April, this was the optimal, or least expensive, collar to protect you against the same, greater-than-20% decline as above over the same time frame.

Optimal hedge on PDD via Portfolio Armor.

Optimal hedge on PDD via Portfolio Armor.

Optimal hedge on GLD via Portfolio Armor.

Here, the cost was negative, meaning you would have collected a net credit of $550 or 1.57% of position value when opening this hedge, assuming, conservatively, that you placed both trades (buying the put options and selling the call options) at the worst ends of their respective spreads.

Wrapping Up: Another Way To Lower Hedging Cost

I suspect that some readers may feel the first hedge above was too expensive, but that they may not be willing to cap their possible upside at 20% between now and April, as the second hedge requires. Another approach for these investors would be to use the "change option expiration feature" to scan for optimal put hedges expiring sooner. For example, as of Friday's close, it was possible to hedge against a greater-than-20% decline in Pinduoduo with optimal puts expiring in late October for a cost of about 1% of position value.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.