Summary Coinbase management is making all of the right moves from a business and regulatory standpoint. The stock is oversold and has the potential to bounce back. Selling puts to earn yield and mitigate risk while getting some crypto exposure seems like the best course of action. Since going public, Coinbase ( COIN ), the leading regulated exchange in the crypto space, has suffered a prolonged drawdown in its stock price. The day of the IPO was the company’s all-time high, and since then shares have sunk in basically a straight line. While the fundamentals of the company leave something to be desired, the firm remains a bedrock crypto institution and household name. We believe that management is taking the right steps to diversify the company’s revenue base and cut bloat, which improves the fundamental side of the equation considerably. On the price action front, technical indicators suggest that the stock is oversold and poised for a rebound. This setup presents an attractive opportunity for income-seeking investors. By employing a short put strategy, we can capitalize on this situation while minimizing risk and generating a solid chunk of income. With an extremely high probability of success, the trade idea we’ll outline is not only compelling, but also - we think! - the best risk adjusted way for everyday investors to potentially profit off of exposure to the crypto markets. Financial Results As we just mentioned, Coinbase has a rocky financial track record; it’s good to know that up front. While the company remains capable of producing tremendous revenues and profits in bull/active crypto markets, cash flow dries up and the company dips into the red when interest in crypto dies down: SeekingAlpha At its peak in Q4 2021, COIN produced almost $1.4B in operating income, which is more than triple what Nasdaq ( NDAQ ) earned that same period. However, since that peak, operating results have been mostly lackluster. Revenue declined 75% over the next 12 months from $2.4B to $604 million, and operating profits went into deep into the red. The culprit here is Coinbase’s business model, which is mostly based around transaction revenue: 10K COIN calls this “Net Revenue”. “Other Revenue” is stuff like Coinbase One (COIN’s subscription plan), Coinbase Cloud fees, Interest income, Custodial fees, and Blockchain Staking Rewards. As you can see, as the crypto bear market took hold, transaction volume went down, and digital assets had their prices slashed in kind. This proved to be a 1-2 punch in terms of revenue impact, which caused the recent operating losses. However, Brian Armstrong and management have shown keen awareness of this problem and continue to move towards diversifying the business away from pure maker/taker fees. To this end, Coinbase is making serious moves. It has been reported that the firm is looking into starting an offshore futures exchange , and the company just announced the launch of Base , its own Ethereum L2 rollup chain. These initiatives and others should begin to shift the profile of Coinbase’s revenue in the future, which is beneficial for shareholders that have been on a bumpy ride so far. Revenue is just half of the equation, though. Management also have a keen eye on expenses within the organization. In the most recent quarter, Coinbase actually produced an operating profit for the first time since Q4 2021. With revenues still down more than 60% from highs, this recent profit is a consequence of management taking a serious axe to the company's cost structure. And, given than revenue has begun to rebound over the last two quarters, it's clear that this reduction in headcount and other spend is not having an impact on the success of the product. As users ourselves, we can also say anecdotally that it seems that the company is moving faster to release better products, like the company's recent TradingView integration into its PRO offering, and simplified / improved UI and UX. Between the revenue mix strategy and cost structure agility, Coinbase has proven through the recent volatility that it has tremendous operating leverage, which is an excellent quality in a long-term investment. Now that management has also "taken the hint" when it comes to profitability, it seems unlikely that costs will balloon again any time soon. All in all, we think it's a good time to get involved in the unfolding fundamental story. Technicals As we stated at the start, Coinbase shareholders have had a rough ride since IPO day: TradingView Shares have not only underperformed the market (which is obvious), but they have also underperformed the crypto market as a whole: TradingView Bitcoin and Ethereum have actually held up much better in the bear market for digital assets, which may surprise some investors. Conversely, COIN stock outperformed considerably in the first three months of this year when Bitcoin and Ethereum caught a bid: TradingView Taken together, COIN shares throughout history should be viewed as a leveraged proxy to mainstream crypto assets like Bitcoin and Ethereum, given how much the underlying business model has relied on trading interest and fees. In addition to the underperformance, COIN stock is also currently oversold on various timeframes. The Weekly RSI shows a reading of 49, which is relatively weak In fact, on the weekly timeframe, COIN has never printed a value higher than 62: TradingView This means that for the entirety of Coinbase’s history as a public company, the stock has never been “overbought” on higher time frames. We don’t expect this to be the case forever. The Trade While we like the risk/reward in owning the shares from these levels, COIN is an inherently volatile stock in an inherently volatile market. Buying the stock may be the right move for some volatility junkies, but for folks with a more moderate risk tolerance, the best way to get involved in the stock is by selling out-of-the-money put options. Selling put options can be an effective way to generate income and mitigate risk while expressing a bullish view on an oversold stock like Coinbase. When you sell a put option, you collect a premium upfront and agree to buy the underlying stock at the strike price if the option is exercised by the expiration date. For this situation, we like the July 21st, $35 strike puts. Strike & Expiry (TradingView) They currently pay $125 per contract, which is a 3.7% cash on cash return over the next 71 days. This annualizes to a healthy 19% yield. The options markets also estimate that these contracts also have 92% probability of expiring at max profit, which is VERY high. In return for this income, you take the risk of needing to buy COIN shares at $35 per share sometime between now and mid-July. $35 is a great point of support in the stock, and it also represents a 45% discount from the current price as of writing. In other words, it’s a huge potential discount on this bedrock company. All in all, either earning the yield or being assigned shares looks like a win-win to us. Risks While the trade idea presents a high probability of success, it's crucial to be aware of the potential risks associated with the trade. Here are some key ones to consider: Business Execution : Coinbase’s ability to effectively manage its costs will be crucial in improving profitability and growth. The company needs to do more with less, and if it appears management is letting bloat slip again, then that will be negative for earnings and the stock. Permanent Loss : If the stock goes to zero, then these contracts would still require you to purchase the stock at $35 per share. The loss profile here is no different than simply holding the stock outright, and you could still exit the option position at any time, but it is a remote possibility that this extremely adverse situation could occur. Competitors : Coinbase is a big player, but tiny in comparison to Binance, its biggest competitor. Coinbase effectively has the U.S. market cornered, but expansion to other territories may be harder given the increased competition offshore. Regulatory : This is the biggest risk with owning COIN. Gary Gensler has provided effectively zero useful or actionable information for the industry, regulating instead with blog posts and wells notices. This poor approach to industry regulation has created a highly uncertain environment that could get worse or begin to materially harm COIN’s business. Technical Sentiment : Despite the oversold condition of COIN stock, there's always a risk that negative sentiment or downward momentum could persist longer than anticipated, impacting the trade's success. Summary In conclusion, Coinbase presents an attractive opportunity for income-seeking investors looking to capitalize on the stock's oversold condition, competent management, and high operating leverage. By employing a short put strategy, we can generate income, mitigate risk, and take advantage of a potential rebound in the stock. While recent financial results have been less than stellar, the company's strong brand equity and recent tactical moves have the potential to overcome current market challenges. With a high probability of success, the trade idea we outlined offers a compelling way to participate in COIN’s future, while minimizing downside risk.
