Alibaba Group Holding Ltd (NYSE:BABA) stock recently leaped higher on a strong statement from management that fundamental expectations were too conservative. BABA stock spiked almost 20% in hours. I’ve rarely seen such a big spontaneous adjustment in valuation in a stock this mature.
Since the spike, Alibaba shares tested the lower gap-up limit and bounced off it. Now, the stock is looking technically bullish at the upper end of the two-week range. Alone, this is a bullish posture, but considering that equity markets in general are precariously perched, I believe that BABA is vulnerable to another retest of the gap below.
Practically speaking, this would be a dip of 8% to 10%.
This wouldn’t change the trajectory of what Alibaba’s management just shared, mind you. But stocks don’t usually go straight up even when management says it could. There usually are periods of consolidation where the stock gives back a little so it can reset another push higher.
So before you send out the posse from my arrest for shorting a nice fundamental headline as BABA stock recently enjoyed, I’ve been sharing winning bullish trades on the company that delivered easy profits, like this one. So I go into this bearish setup with profits in hand and no money out of pocket.
In fact, I’m going to use the value inherent in Alibaba stock to finance my bearish trade. This is not a knock against the company’s prospects, but rather one that bets against the short-term price action. With the risk of sounding cliche, I believe that the move higher came too far too fast.
Expectations are too lofty for BABA stock, too. Analysts are one-sided in their expectations, with 21 buys, 19 outperforms and just two holds. This elevates the risk of disappointment across the next two earnings seasons.
Alibaba is not cheap. It carries a price-to-earnings ratio twice that of Microsoft Corporation (NASDAQ:MSFT) and three times that of Apple Inc. (NASDAQ:AAPL). And those two pay hefty dividends on top of impressive stock appreciation.
How to Trade BABA Stock Here
The bearish bet: Buy the Sep $140/$135 debit put spread for $1.8. If prices fall through my spread before mid-September, I stand to double my money.
As I previously mentioned, I will use Alibaba’s inherent value to finance my bet.
The bank: Sell the Dec $115 put. This is a bullish trade for which I collect $2.25 to open. Here I have an 85% theoretical chance of success. Otherwise, if the stock falls below my strike price, I will need to own the shares. I could suffer losses below $112.75 at that point.
Taking both trades, I am threading a fairly wide needle eye. I need BABA stock to fall below my debit spread by mid-September. But then I also need it to stabilize and hold above the put that I sold through 2017.
Investing is risky, so never risk more than you’re willing to lose.
Learn how to generate income from options here. 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.
