Alibaba Group Holding Ltd (NYSE:BABA) came out of the IPO gate with force. Then, hit by business ethics headlines, BABA stock got cut in half from its highs.
There is no doubt that Alibaba is a cash cow. Few companies can generate similar numbers. BABA stock is outperforming the markets up 40%-plus for the past 12 months. Year-to-date, it is up an impressive 17%.
Click to Enlarge Fundamentally, Alibaba seems to be on decent footing with the current issues at hand. Its most recent earnings report was well-received by Wall Street. Upon its release, Alibaba rallied $10 to $98. It since has given up $3, but still is well above its recent trading range.
Management is executing as if it recognizes the importance of user engagement. This is what is making winners of Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB).
Technically, I don’t like to chase big moves with bullish positions. I fear that I would be buying someone else’s profits. I typically like to go long good tickers on bad days. But this market is so relentless that it’s making it hard to wait for pullbacks.
Even in this environment, I can find decent levels in BABA stock against which I can cautiously sell risk. (Or, in other words, generate some income!)
2 BABA Stock Trades
Trade No. 1: Sell the BABA Jan $75 put for $1.30 per contract. Ideally, BABA stock needs to stay above $75 per share through mid-January. Only sell naked puts if you’re willing and able to own the stock at the strike sold, even if it falls lower.
This trade gives me a 22% buffer from current price, meaning Alibaba can fall 22% before reaching my line. Breakeven is $73.70 per share.
To reduce my exposure, I want to balance this trade out with a bearish trade.
Trade No. 2 (The Hedge): Sell a BABA Jan $115 call for an additional 92 cents per contract. To win, I need Alibaba shares to stay under $115 through mid-January. Again, selling naked calls is dangerous. Only do this if you’re willing to be short BABA above the sold strike. This also gives me a 22% buffer between current price and my risk line.
Taking both trades puts me in a self-hedge sold strangle with +/- 22% buffer from current price. In total, I collect $2.22 per contract. I want BABA stock to stay between $75 and $115 per share between now and mid-January. I’m not obliged to hold either through expiration; I can close either for partial gains or losses at any time.
Options
There are less aggressive ways of setting this sold strangle. I can modify it to be a sold iron condor. This would define my maximum risk.
For example, I could sell a BABA Jan $77.5/$72.5 credit put spread for a net credit. Against it, the hedge could be a January $115/$120 credit call spread. I would collect a total net credit of 95 cents per contract.
If successful, this trade would yield 23% on money risked.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and StockTwits at @racernic.
