The Chinese consumer and bullish investor appears alive and well in Alibaba Group Holding Ltd (BABA). Nonetheless, the better bet may be to shop for a short position on the internet giant by going bearish with options. Specifically, with a bear put spread. Let me explain.
In early May, shares of Alibaba rallied nearly 4% following a much stronger sales increase of 39% at the company — insinuations of a more frugal Chinese consumer could be premature or altogether wrong.
Yet, while some investors are buying the goods Alibaba is selling, others are not; they’re still shorting BABA stock aggressively.
With an existing days-to-cover ratio of nearly eight days and legendary bear Jim Chanos’ Kynikos Associates reaffirming its wager against BABA stock days after Alibaba reported — throwing caution to the wind may prove unwise for investors.
Let’s face it, short sellers typically get a bad rap from the media and bullish investors that dominate the market. But a short seller like Kynikos doesn’t have a conflict of interest when it decides to take on a company like Alibaba. And that’s important to understand.
Sure, Kynikos gains notoriety and assets under management, but profits aren’t guaranteed. Further and unlike the investment banks, their reasons for shorting, to profit from an overvalued or corrupt company are nearly altruistic compared to Wall Street’s incestuous bullish ratings game tied to a fee-based meal ticket.
Maybe Kynikos isn’t going to find its next Enron or a nice sized profit similar to its short stake in a weakened SolarCity Corp (SCTY). But given the type of company and a price chart pointing lower, BABA stock is worth the attention of bears.
BABA Stock Weekly Chart
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Alibaba shares gapped higher following its early May earnings report, but investors failed to reclaim the mid-April high. The subsequent price action has confirmed a lower high pattern at the 38% retracement level after filling a bearish gap.
In conjunction with the stock also failing to move back above its initial public offering low set back in October 2014, shares of Alibaba are in position for shorting until (and if) resistance above $83 is decisively broken.
BABA Stock Bear Put Spread
Reviewing BABA’s options board, premiums are cheaper overall, but I like the idea of reducing Greek risks should an undesired short squeeze occur. Having said that, the August $77.50/$70 bear put spread for $2.40 is attractive.
A max payout of $5.10 returns 213% below $70 in BABA stock at expiration. At the same time, this defensive vertical can only lose $2.40.
Compared to the sometimes much larger open-ended loss associated with shorting BABA stock, the spread certainly offers nice protection. And in those other lesser, but technically important situations such as BABA getting above $83 — in conjunction with money management, the vertical trader is still looking like the smarter money.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.
