In October 2020, I opened a long put option position in online marketplace operator Etsy (NSDQ: ETSY). A put option increases in value when the price of the underlying security goes down. The stock had been on a tear, and I felt it was due for some reversion to the mean.

I reasoned then, “What I don’t understand is why Etsy’s share price has tripled in value this year despite the company’s penchant for not making much of a profit nor paying a dividend to its shareholders.” That day, ETSY closed a little over $153.

Turns out, I was a year early. ETSY continued to appreciate until November 2021, when it topped out near $300. But since then, it has been all downhill. Last week, ETSY slipped below $115 to give back all of its gains over the past thirty months. 

Actually, ETSY bottomed out below $70 in June of last year. At that time, the stock market was in full sell-off mode after the Fed began raising interest rates. Wall Street quickly abandoned the high multiples to sales and earnings that drove ETSY so high in the first place.

From a longer-term perspective, ETSY is back on the growth curve it was moving along before the outbreak of COVID-19 three years ago. The distortion caused by the subsequent pandemic is mostly gone. Instead, we now have inflation and the likelihood of an economic recession to worry about.

Recession Play

On February 22, Etsy released its fiscal 2022 Q4 and full-year results. The bad news is that gross merchandise sales (GMS) for the Etsy marketplace fell 3.5% during the fourth quarter. The marketplace accounts for roughly 90% of Etsy’s consolidated GMS, which was down 4%.

The good news is that consolidated revenue for the marketplace was a record $807 million during the quarter. That was 12.6% higher on a year-over-year basis. However, higher operating costs reduced Etsy’s consolidated net income margin by nearly a third.

That is not the type of news that Wall Street wants to hear right now. Since then, ETSY is down 10% while the overall stock market is flat.

All of that induced an analyst at Jeffries to reduce their one-year price target for ETSY from $150 to $85. If that prediction proves true, ETSY will lose another 25% over the next twelve months.

I don’t think that is likely to happen. Just as the pandemic forced consumers to shop from home, I believe a recession would induce consumers to cut costs. One way to do that is to buy homemade goods from Etsy rather than pay full price for commercial goods.

And if the Fed is successful in its effort to drive up unemployment, Etsy could also see more people use its marketplace platform to generate income. When times get tough, people quickly change their behavior to remain solvent.

In short, I now view Etsy as a recession play. There aren’t many businesses that would benefit from a recession, but Etsy is one of the few that could see both supply and demand for its service increase under that scenario.

Staying Put

This time, I am going to sell a put option to open this trade instead of buying one. Last week while ETSY was trading near $109, the put option that expires in January 2024 at the $85 strike price could be sold for $9.

That money is mine to keep no matter what happens next. If the Jeffries analyst is correct and ETSY falls that far, I could end up having to buy it for $85.

I’d be happy to do that since it would represent a discount of 22% off of its current share price. If a recession pushes ETSY that low, the subsequent recovery should send it soaring.

If ETSY does not fall to $85 by the time this option expires, this trade is over. I get to keep the $9 premium I received now, which amounts to a 10% cash return on the cash my broker will require me to keep on margin in case I have to cover this trade.

Given the outlook for the economy, I will happily accept a 10% return on my money over the remainder of this year. I hope a recession doesn’t undermine the stock market, but if it does then I’ll make money either way with this trade.

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