Alibaba Group Holding Ltd (NYSE:BABA) has been on quite a tear over the past two weeks. BABA stock has rallied 7% since July 4, moving from the $141 level to trade at new all-time highs yesterday at $153.70. But eventually, price does matter, even for a momentum darling like Alibaba. Earnings are due August 10 and I expect the recent rally in BABA stock to stall out over the next few weeks in front of the earnings report.
Our very own Dana Blankenhorn penned a very detailed report just yesterday laying out his bullish thesis along with several differing viewpoints. He readily admits that Alibaba may be in a bubble, but that says that doesn’t mean it is going to pop anytime since soon. Yesterday’s price action, however, may be an impending sign that at least a little air is beginning to be let out of the BABA Bubble.
A look at the chart action shows shares of Alibaba put in a reversal day yesterday. BABA stock rallied to fresh all-time highs at $153.70 before reversing to close lower on the day, and near the lows, at $151.23. This type of price action is many times emblematic of a short term top in the stock, with buyers finally becoming exhausted. It is an even more powerful indicator given the magnitude of the recent rally in BABA stock.
Valuation is also getting a little stretched in Alibaba. The current P/E ratio of nearly 60 is most assuredly not cheap (nearly triple that of the S&P 500). The 2018 forward P/E of 40 is far from a bargain as well. It is also important to consider that Alibaba is now approaching a $400 billion market cap, so future growth rates will be increasingly difficult simply due to the law of large numbers.
I am not looking for an imminent collapse in BABA stock, nor in the market generally. God knows the powers that be will likely never allow that in the ultra-low-volatility, manufactured market that has become the New Abnormal.
Instead, I think a period of sideways action in front of earnings is the more probable scenario, especially given the technicals and fundamentals.
So to position for a period of consolidation, a call credit spread trade is the optimal way to make money for nothing.
BABA Stock Trade Idea
Buy BABA Aug 4 $157.50 calls and sell BABA Aug 4 $155 calls for a 65-cent net credit.
Maximum gain on the trade is $65 per spread with maximum risk of $185 per spread. Return on risk is 35.1%. The short $155 provides a 2.5% upside cushion to the $151.23 closing price of BABA stock and is also well above the all-time intraday high of $153.70. The August 4th expiration date is prior to earnings due on August 10 to avoid earnings risk.
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 timbiggam@gmail.com.
