Trade of the Day: Alibaba (BABA)

Options for Alibaba (BABA) listed last week, and the chains have been active as traders place their bets on where shares will be this month, the rest of the year and into January 2017.

The longer-term options (known as LEAPs) are up for grabs, and the near-term October options are commanding premium prices but have decent bid/ask spreads, within a nickel or dime of each other. Of course, with a limited chart history of 11 trading days, predicting where BABA shares will be in three weeks or three months would be useless on a technical level.

Headline news and analyst upgrades or downgrades will sway shares higher or lower for the first few months and, at some point, wild price swings are likely in store. The recent initial public offering (IPO) was the biggest ever in the United States, and it is inevitable that greater volatility will come given the size and scope of the company.

I mentioned when shares made their debut that Alibaba could trade to $105 — or $35 — based on its proposed $68 offering price. On the first day of trading, Sept. 19, shares opened at $92.70 and reached a peak of $99.70 and a low of $89.95. So my $105 target nearly triggered on the first day of trading.

Since then, Alibaba has failed to clear its opening day high, while setting a low of $85.61 on Thursday. This has already been a 14-point round-trip in two weeks.

With shares near $90, this would put $105 or $75 in play based on a $15 up or down spread. I doubt this type of move will happen over the next few weeks, but it could over the next three months.

With my research based on this prediction alone, I took a peek at the BABA January 2015 100 calls (BABA150117C00100000) and the BABA January 2015 80 puts (BABA150117P00100000) for a strangle trade to play a possible $15 move in three months.

These option strike prices are roughly $10 away from the current level of the stock, and it would cost slightly over $6 to purchase both sides of this trade. This means Alibaba would need to be above $106 or below $74 for this strangle option trade to break even, technically, by mid-January. If shares are above $110 or below $70, this trade would come close to making a triple-digit profit, as either call or put option would be worth at least $10.

The time premiums built into these options will also have an effect on the trade, as a quicker move with volatility could lead to “inflated” prices.

Those looking for a nearer-term trade could buy to open the BABA October 95 calls (BABA141018C00095000), which have open interest of nearly 12,000 contracts, and also the BABA October 85 puts (BABA141018P00085000), which have open interest of more than 5,000 contacts. Purchasing these options together would also create a strangle option trade, with a price of $1.65 for both the call and put option.

With these options expiring in less than two weeks, the risk/reward of this strangle option trade is also high, as shares would need to be above $96 or below $84 just to possibly break even.

Some might argue that selling these options would be a better alternative, but I don’t trade “naked.” Naked option selling is extremely risky because you are selling options on a stock you don’t own.

While I like the idea of these speculative trades, the risk/reward wasn’t appropriate for my official Momentum Options recommendations, but I wanted to offer it as a possibility for a “Vegas money” trade. I do also plan on trading directional call or put options on Alibaba at some point this year; I just have to be patient and watch the headlines.

The company is scheduled to report earnings in mid-November, and that is likely when shares will either shine…or they’ll fold like a cheap lawn chair.

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