Alibaba Group Holding Ltd (NYSE:BABA), the China-based Internet commerce giant and largest IPO to date is set to release earnings next Thursday, May 7. But with some 1999-style partying going on in related markets and a quiet period of sorts adding value to BABA stock, buying long calls looks like the right play right now.
When Alibaba stock went public last September, it was the talk of the Street. It also was a coup of sorts for the New York Stock Exchange, which listed the Alibaba stock IPO, raised a staggering $25 billion for the company and put BABA’s market cap at $231 billion after the first day of trade.
The past several months have been less kind. A disappointing earnings report, regulatory scrutiny over counterfeit knock-offs and a massive 340 million-share investor lockup period expiration have been the primary drivers keeping BABA bulls at bay.
BABA Daily Chart
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The irony is that as investors have been snapping up shares of Chinese companies and listed indices like the iShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI) following a surprise monetary loosening by China’s central bank, BABA shares have stayed shelved like old, unwanted merchandise, as our daily chart shows.
For nearly two months, Alibaba stock has been in its own little, quiet period. Technically speaking, BABA has been consolidating laterally in a tight range approximately 7% wide. The churn is centered on the prior lows in BABA stock.
Given the undercut in price and the rather large amount of BABA that shareholders now allowed to sell — but obviously are unwilling to do at these levels — BABA looks poised to break out from its low-volatility situation and play catchup with its country peers.
Alibaba Earnings, Volatility and Options
When Alibaba earnings come out May 7, analysts expect profits of 28 cents per share. In its short history as a public company, Alibaba has managed to miss on its bottom line by 32% and 11%, with BABA shares showing mixed reactions of about 4.5% and around -9%.
Currently, 40% implied volatility in the May contract is estimating a 68% chance BABA shares will remain within roughly 7.5 points of Tuesday’s closing price near $85. Thus, you get an expected trading range as high as $92.50 and as low as $77.50.
For more aggressive, self-directed traders, the May $87.50 call is attractive. Priced at $2 per contract, the return on investment is 150% if BABA manages to land on its one standard deviation estimate calculated above, come expiration.
BABA Long Call Strategy
While holding and hoping might work, I like this call purchase as one to manage and adjust prior to the report if given the opportunity. The near-40 delta and one that will increase means if BABA were to retest its range highs of $87.69 would easily yield a profit of $1 or better and in excess of a 50% return.
In a situation where Alibaba stock tests resistance, I’d look to sell a portion of the BABA calls and leave a very low cost position or even “free trade” on for the actual event.
On the chance that shares of BABA don’t join the current party alongside its very green, country peers, you should put a money stop of $1. Contracts nearing expiration and priced on earnings and time premium demand extra attention — without buying something you truly hadn’t bargained on.
Disclosure: Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.