After a period of ever narrowing consolidation, shares of Alibaba Group Holding Ltd (NYSE:BABA) finally showed signs of life this week. BABA stock rose 1.73% Monday and closed just above the critical $105 resistance level, but settled just below $105 Tuesday. Whether this becomes a legitimate breakout or a failed breakdown, a cheap options straddle can position to profit for a move in either direction.
Click to Enlarge As the chart shows, Alibaba had been coiling ever tightly, putting in a series of higher lows without making a new high. Yesterday finally saw some volatility in BABA stock, and volatility usually begets volatility.
If Alibaba can convincingly hold on to the $105 level, a technical breakout toward the all-time highs at $110 may ensue. A failure to hold the critical $105 level may lead to a retest of the lower end of the recent trading range at the $100 level.
While much has been written on Alibaba from a company standpoint, including some extremely insightful commentary from fellow Investorplace contributors Laura Hoy and Josh Enomoto, the fact remains that BABA trades more on technicals than fundamentals. With algorithmic trading now dominating both volume and price action, I expect that theme to become even more dominant.
One of my favorite technical indicators are Bollinger bands, which combine a moving average along with a volatility component. When Bollinger bands tighten, the bandwidth narrows, indicating that the underlying stock may be getting a little too quiet and is poised for a big move.
A look back over the past year shows how effective this was at predicting subsequent major moves in BABA. With Bollinger bandwidth currently at the lowest level of the year, I expect some fireworks may be in the offing in the near term.
Click to Enlarge As I mentioned, Bollinger bands include a volatility component. In my role as option analyst, certainly volatility (and especially implied volatility) is one of the cornerstones of my analysis.
With historic volatility at only the 2% percentile and implied volatility at only the 13% percentile, things are most decidedly getting overly complacent.
A quick straddle analysis will serve to highlight just how complacent. The last time Alibaba stock closed at these levels was Oct. 11, 2016 with BABA closing at $105.23. Yesterday, BABA stock closed at $105.18, so a virtually identical closing price.
Yet the straddle prices between those dates are far from similar. Last October, the at-the-money $105 straddle with 38 days until expiration was priced at $11 (40.37 IV).
Yesterday the same straddle, with 39 days to expiration, was priced at $5.75 (20.50 IV). So the same straddle with the same stock price and with the same days to expiration (actually one more) was priced at nearly half the price!
Cheap indeed!
BABA Stock Trade
So to position for an impending move at a critical technical juncture with extremely inexpensive options, a long straddle play makes intuitive sense.
Buy to open BABA April $105 calls and buy to open BABA April $105 puts for a $5.75 net debit. These are the traditional monthly options that expire April 21.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
