NTES (Short)...

Before I proceed to detail my first short pick on here, I need to provide a quick overview of my shorting methodology. Ok, for starters, I short using puts and/or put spreads most of the time, but sometimes I will short using common stock as long as I can hedge it somehow, be it through selling covered puts or buying calls at a higher strike. So if it's not a stock with a good options chain, I'm probably not going to look to short it. Shorting is inherently more risky than going long because reward/risk symmetry is not your friend. Said another way, if you go long a stock, your theoretical maximum profit is infinite and your maximum theoretical loss is 100%, but if you get short of a stock, your theoretical maximum profit is 100% and your maximum theoretical loss is infinite (in reality, your broker would most likely automatically close out your short once the losses get too high). Also, when picking stocks to short, the primary driving force is the technicals. Fundamentals don't matter as much to me when shorting (shorting something because it is 'overvalued' is a great way to lose money because overvalued stocks tend to become more overvalued before they become fairly valued). That being said, if a stock scores strongly on the screens, I'll be a bit more cautious when shorting it, versus if the screens say it's a weak stock, at which point I'll be a bit more aggressive.

So, onto NetEase.com. Why am I picking on this Chinese internet gaming/advertisement firm? Simple - the chart is awful. The fundamentals are actually pretty decent, as it scores quite highly on the Peter Lynch screen (93%) and 72% on the Motley Fool screen, but beyond that, it doesn't get above 70% on any screen. NTES doesn't report again until late February or early March, and it has a good enough options chain for me.

So, I hate the chart. It was looking ok until this week, when NTES broke down below its 200-day EMA (and multi-month) support on heavy volume. NTES was down ~10% last week. The stock was as high as $42 a couple weeks ago, but it closed Friday at $33.50, so this is a pretty oversold stock. Shorting an oversold stock like this is playing with fire, especially considering that NTES has been down 10 of the past 11 trading days, including the past five straight. This one is set-up to have a short-covering snapback rally, which would present a safer shorting opportunity. What I want to see in NTES is a low-volume rally up towards the 200-day EMA, currently around $36.50. That's when I'd be looking to start my short, and I wouldn't give it much room above the 200-day EMA because the most recent high was up around $42 and that's a lot of pain to endure. Longer term, based on the weekly chart, I would expect NTES to have downside towards the upper or mid $20's, as it has a substantial base built there.

For options, I like the February $36 puts if I was going to short it right here, right now. However, I believe it will have a little rally and will present a better entry in these puts or even the February $37 or $38 puts. If I was going to short it right now, I would form it into a debit put spread with the February $36 and $33 puts for ~$2.





Position: none

Disclaimer: This is not a recommendation and is presented for informational purposes only.