In a previous article on Alibaba (BABA), I had postulated that Alibaba stock was due for a period of consolidation after an impressive rally.
Now, with BABA trading at virtually the same price as it was when I wrote that a month and a half ago, I am looking for the consolidation period to end and for a breakout in BABA stock.
Click to Enlarge As seen in the chart at right, BABA has major upside resistance at the $85 level, with three previous failures to break through this area (late July, early November and early December).
To the downside, both the 50-day moving average of $78.41 and the 200-day moving average of $79.26 have proven to be solid support levels.
With a series of higher lows, and with overhead resistance at $85 still looming, an ascending triangle pattern has formed for Alibaba stock, as seen in the second chart, below.
This is a bullish continuation pattern from a technical analysis perspective.
Click to Enlarge The news yesterday that Alibaba will be partnering with Disney (DIS) to sell streaming content in China via the DisneyLife initiative was certainly viewed positively, with shares of BABA jumping over 2% following the news.
The options market is displaying the same sort of consolidation as BABA stock, with both implied and historic volatility levels around the 50th percentile. Given that overall implied volatility measures such as the VIX are at recent highs, BABA options are cheap on a comparative basis.
This relative complacency also points to a potential breakout on a contrarian basis.
To play the expected upside breakout in BABA, I would look to position with a long call spread. Specifically, I would buy the BABA Jan $85 calls and sell the BABA Jan $90 calls for a $1.40 net debit. The initial spread is long 23 deltas, with the short strike positioned just below the $90.55 gap low from Jan. 29.
The total risk on the trade is $140 per spread, with the maximum gain being $360 per spread. Return on risk is 257.14%, with maximum gain being achieved if BABA stock is above $90 at January option expiration.
I would look to close out the spread if BABA breaks significantly below the 200 day moving average support.
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.
