The life of Alibaba Group Holding Ltd (NYSE:BABA) as a public stock has been interesting. It burst onto the scene late last year amid much fanfare, but short of one strong month has been kind of a dog.
The one strong month, of course, was the impressive 45% run that carried the stock from the low $80s to $120. The bulls had an opportunity or two to play BABA stock to the long side during the surge, but that’s really been it.
Since then BABA has gradually descended and now sits just a stone’s throw from its all-time low.
Along the way the implied volatility has crumbled as well. The uncertainty surrounding BABA in the aftermath of its IPO pushed implied volatility as high as 48%. As is usually the case, however, time and familiarity with the stock’s behavior have driven implied volatility to its now lowly level of 28%.
The unrelenting nature of BABA’s downtrend has given the bulls little reason for getting involved. That may be changing, however. With its 52-week low looming at $82.81 now is as likely a spot as any for buyers to step up and halt the decline.
If nothing else, the current posture of BABA sets up a favorable risk-reward for long plays. If you use a break of the $82.81 zone as your exit the risk is minimal. And if BABA bulls stage a successful counterattack here and a nice little up move materializes the reward could be high.
Play the Probabilities in BABA with Options
Rather than banking on an epic return of the bulls in BABA — which I count as a low probability scenario — let’s structure a trade that prospers as long as BABA is able to remain above the $82 level.
Sell the Apr $80/$75 put spread for 66 cents or better. The reward is limited to the initial 66 cents and will be captured if BABA stock can remain above $80 by expiration.
The max risk is limited to the distance between the strike prices minus the net credit, or $4.34, and will be lost if BABA sits below $75 by expiration. To reduce the amount of loss consider bailing if BABA breaks decisively below the pivotal support level at $82.81.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.
