Alibaba Group Holding Ltd (NYSE:BABA) is scheduled to report is fiscal fourth-quarter earnings before the market opens Thursday. And while I expect Alibaba to follow in the footsteps of Facebook Inc (NASDAQ:FB) with an earnings beat … I also expect BABA stock to deliver a disappointing performance.
Consensus estimates are for 66 cents per share on $5.2 billion in revenue. The widely followed whisper number, which indicates the opinion of professional traders, is much higher at 76 cents per share. I think Alibaba can clear the consensus, but given the whisper number and the rally in Alibaba shares, I think investors should brace themselves for a negative reaction.
Our own Laura Hoy does a great job delving into the many reasons why she feels that Alibaba stock will have a great earnings report. I certainly agree nearly 100% with her insightful analysis. As a trader, however, I still believe price matters.
BABA stock is now trading with a P/E well north of 50. This marks the highest valuation ever in Alibaba shares and shows just how much they’re priced for perfection. The last time the stock traded at such extremes, we got a short-term top in the stock.
Alibaba has rallied nearly 7% over the past eight trading days, with the stock now trading at an extremely overbought level of 87 on a 9-day Relative Strength Index (RSI) basis. Again, the last time Alibaba was so overbought, we got a top in the stock price.
As I said earlier, I agree completely that Alibaba is a growing and vibrant company. It’s likely to report solid earnings. I just don’t like how far the stock has come on both a technical and valuation basis, especially given that this is a company with a $300 billion market capitalization.
BABA needs spectacular earnings for the stock to head appreciably higher.
In a similar fashion to my latest research piece on Facebook, I expect Alibaba to beat the consensus analysts estimates but have a tepid reaction on the stock. Given the heightened level of implied volatility (IV) in front of earnings, option selling strategies makes sense. So I am going with a similar strategy as my previous winning one on FB.
How to Trade BABA Stock
Buy the BABA Jun $135 calls and sell the BABA Jun $130 calls for an 85-cent net credit.
Maximum gain on the trade is $85 per spread. Maximum risk is $415 per spread. Return on risk is 20.48%.
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.
