Why this big trader is shorting Yelp
Yelp has reported some truly impressive earnings. But that doesn't mean bulls aren't getting well ahead of themselves.
Yelp reported a 1-cent-per-share loss on earnings for the second quarter, which doesn't sound great but did beat expectations of a 4-cent loss. The company's revenue came in at $55 million, up from the $46.1 million that Yelp logged in the prior quarter.
The company managed to pull in a significant amount of new traffic due to its acquisition of internationally focused Qype. This helped Yelp to launch its service in six new markets. And Yelp showed positive growth across the board in categories like mobile and global, as well as in the number of user reviews. All of this has enabled Yelp to take a leading position in the industry, in which it competes with Zagat, OpenTable and Angie's List.
A recent study by the Boston Consulting Group gets to the bottom line of why Yelp could end up being highly valuable. The study found that small businesses that have a free presence on Yelp saw an annual increase in revenue by $8,000 on average. Local businesses that paid for advertisement on Yelp (costing an average of $4,200/year) saw an annual increase in revenue by $23,000 on average. Some segments performed even better than that; for instance, home services saw an increase in annual revenue of $54,000.
The company has a lot to offer local businesses, even if their contribution is free. The initial model of the company has been to attract companies to list themselves on the site, as well as to draw in customers of these businesses to write reviews. In the last quarter, Yelp had over 39 million reviews written by users who visited the local businesses. Yelp keeps bringing in more users, expanding traffic and increasing the number of local businesses that pay for advertising services. More recently, however, the company has been pursuing alternative revenue streams including its purchase of SeatMe, an online reservation service.
(Read more: Cramer: Apple should buy Yelp for $75 per share)
But one trader believes that all the hype surrounding Yelp will fade away by 2014. On Thursday, this trader placed a bearish call spread on Yelp, by selling 1,000 January 34-strike calls for $19.30 each, and purchasing the January 50-strike calls for $8.90. This trade was done for a net credit of $10.40, and has a potential reward of double the risk. If the price of Yelp remains above $50 by January expiration, this trade will suffer the max loss of $560,000; on the other hand, if the price sinks back below $34, the trader is set up to enjoy a gain of $1 million. The breakeven price of this trade is at $44.60, with the loss being to the upside, and the gain to the downside.
Yelp has shown very strong growth from these recent earnings, but with Thursday's 25 percent move, investors may be overestimating the worth of the company. Yet while this might be the time to be a little bearish on the stock and potentially benefit from the inflated options prices, selling a January call spread means taking on a great deal of risk to bet against a company that is showing impressive momentum.