Zoom : Long Straddle
Updated: Feb 1
This association and its publications are solely intended for academic purposes and should not be used as investment advice or be interpreted as such.
Zoom Video Communications, Inc. is a communications technology company, which provides video telephony as well as online chat services through a peer-to-peer cloud-based platform. Zoom is used for teleconferencing, telecommuting, distance education (to name a few), all of which have become more popular given the current pandemic situation.
Eric Yuan founded Zoom in 2011 and launched it in 2013. In 2017, Zoom had a $1 billion valuation due to its aggressive revenue growth, reliability, and ease of use. It first became profitable in 2019 and completed its IPO that same year, but it is in 2020 where Zoom’s software usage saw a significant global increase. Zoom joined the NASDAQ-100 on April 30, 2020, highlighting just how important of a year this was for communications technology companies, with its current market capitalization at $111.56B as of market close on Thursday, January 14th.
Our choice is clearly dictated by both the Covid-19 pandemic and the newly developed vaccines. These two developments, especially the former, have notably affected our social and work life, forcing businesses to find innovative ways to deal with the situation. Most governments issued national shutdowns and the only way for people to still be able to carry out their activities was to work from home. In this environment, Zoom thrived. Its share price increased by triple digits since the beginning of the year, and it is now the most used software for video conferences. In particular, its market share is now 36%, followed by Teams and Skype at 17% and 16% respectively.
However, recently Zoom stock took a near 40% plunge from its October highs of nearly $570 to its mid-January $350 level. This was mainly caused by the progress of the newly developed Pfizer and Moderna vaccines, which are seen as a ray of hope to finally overcome the global pandemic. We believe that the loss in value was due to people’s expectations of finally going back to a normal work life, hence limiting the need for videoconferencing applications. In our analysis, on the other hand, we also need to include the benefits of working from home and the long-lasting effect of this new way of working.
The dramatic surge in demand for virtual conferencing as a result of the pandemic has left investors wondering whether Zoom is capable of sustaining long term growth or whether larger players would enter the market and take over. Therefore, the key metrics to analyze Zoom’s performance is the growth in the number of business customers with more than 10 employees that have purchased Zoom’s subscription plan. In the past 3 quarters, Zoom grew its business customers with more than 10 employees by 430%, and as a result saw its revenue increase by 313% within the same period.
Most notable in the list of fundamentals is Zoom’s valuation. A Price/Earnings ratio of 221.92 indicates a very expensive stock price for Zoom, which is a lot higher than the industry average. However, this can be noted down to the boom of zoom around April 2020. The exceptional year that Zoom had is further visualized on their EPS and Revenue growth this year, which must be taken with a pinch of salt. Yet, based on estimates the EPS will grow by 330.76% on average per year. Furthermore, in terms of liquidity, Zoom shows that they are in a healthy financial position with an industry comparable current ratio.
Recap & Motivation
We believe the main downside risk to ZM in the coming months is the increasing hope for a return to normalcy as a result of a rapid vaccine rollout. On the other hand, we consider the main potential upside to be that the working from home system is here to stay even once we achieve herd immunity. Regardless of which force will be greater, we believe there will be changing investor sentiment, which will ultimately make our long straddle strategy profitable.
A survey by the BBC has highlighted how, in May, “55% of US workers want a mixture of home and office working. In the UK, employers expect the proportion of regular home workers to double, from 18% pre-pandemic to 37% post-pandemic. In China, employment expert Alicia Tung has predicted that in 10 years’ time, there will be a 60/40 split of onsite/remote work”.
Moreover, it is important to highlight how, even though it is true that the vaccine has proven to be effective against Covid-19, its long-lasting effects are still to be measured.
In particular, three aspects are of main importance:
the first one is the amount of people that would need to be vaccinated in order for herd immunity to come into play.
The second is the fact that it takes a few weeks to vaccinate a single person, as individuals need to be injected twice for the vaccine to be effective.
Lastly, there is still no research (for obvious reasons) about how long the vaccine will work. Hence, going against all hopes, it is our opinion that the Covid pandemic will not end in 2021 and that people will still have to work from home and utilize technology aids.
We believe that the benefits provided by the working from home (WFH) culture (increased productivity, flexibility, decreased traffic congestion, etc) are here to stay, and Zoom will play a critical role in delivering a solution for companies looking to permanently incorporate the WFH system.
By looking at the Standard Deviation of Zoom, we notice a very erratic trend. In particular, both the simple moving average and the exponentially weighted moving average have both upwards and downwards spikes. Our bet is, given that the situation is still very unclear, that this erratic trend will continue and hence we can bet on a new spike in volatility.
It is then our idea to not bet on a specific target price for Zoom. Even though many analysts are currently in favor of a buying strategy, the shares of the company are rapidly losing value. Moreover, there is too much uncertainty about how the world will fare against Covid to make an accurate prediction. Our suggestion is therefore to bet on that uncertainty and using a long straddle would allow us to do exactly that. By keeping a delta neutral strategy and being long Vega, we can take advantage of sudden news that may come up about the pandemic without necessarily taking a positive or negative direction. Furthermore, we do not intend to keep our strategy until maturity. While it is true that a shock might come at any time, we also need to consider the negative effect of theta on our strategy. With every passing day, our options lose their time value, and that is something we need to consider when selecting the best strategy for our position.
The figure above highlights how ZM’s 30-day Implied Volatility (IV) is at relatively low levels since the pandemic began. We believe IV will rise to roughly 70-80 in the near future, thus benefiting our strategy. Additionally, the RSI and MACD indicators in the figure below show a potential bullish run in the coming week.
Our play consists of a delta neutral Long Straddle. The expiry would be 12 Feb 2021 with a strike at 377.5. In other words, our strategy involves buying both a call and a put at the money. The entry cost of this trade is 54.65, with break-evens at expiry of $429.65 and $320.35. However, as mentioned previously, the ideal holding period is about a week into the contract, and since the strategy is focused on profiting from volatility, it requires selling both contracts at the same time.
Assuming both contracts are sold by market close on January 21st, the max potential loss is $711, or 13% of the total entry cost. The max potential profit is infinite.
The pros of our play are that our profit potential is unlimited while our max loss is limited at $711. Again, this is assuming both contracts are sold at the same time within the first week. On the other hand, our strategy requires a big price movement within a short time period in order to realize any sort of profit. If this price movement does not occur, the strategy will suffer in terms of its premiums.