Following an earnings report last week that beat on revenue but missed on earnings, shares of Alibaba Group Holding Ltd (BABA) jumped 4% to close at $78.83. Since that time, BABA stock has basically drifted sideways, meeting some upside resistance at the $80 level. I look for Alibaba stock to close the post-earnings gap and retrace back to the $75 level over the next few weeks.
Click to EnlargeThere is major overhead resistance looming at the $85 level in Alibaba, which should provide a formidable headwind for BABA stock moving forward. Previous attempts to pierce this level were met with strong selling.
While BABA revenues did come in better at $3.75 billion versus $3.59 billion expected, earnings of 47 cents were actually well below consensus of 60 cents. Spending increased to 60% of revenue versus 58% from a year ago, leading to the earnings shortfall. Noted short seller Jim Chanos continues to have a short position in Alibaba stock, having questions regarding the cash flows and financial metrics.
Click to EnlargeMr. Chanos goes on to note his bearish view on China as another reason he is short BABA. Alibaba stock is normally correlated to the iShares FTSE/Xinhua China 25 Index (ETF) (FXI), but recently that correlation has diverged, with BABA being a big out-performer. I look for that correlation to revert, a decided negative for BABA shares.
The options market is painting a very complacent picture post-earnings for BABA stock, with implied volatility (IV) at the lowest level since June of 2015. IV is normally a reliable contrarian indicator, Previous instances when IV was this low marked significant tops in Alibaba stock, as seen in the chart.
Click to EnlargeWith implied volatility at low levels, long volatility option positions are favored. With my expectation for a pullback to the first support level of $76 level over the next few weeks, a long put calendar spread is my trade structure.
Specifically, I would look to buy the BABA June $76 puts (expire 6/3/16) and sell the BABA May $76 puts (expire 5/20/16) for a 62 cents net debit. The maximum risk on the trade is $62 per spread. Maximum profit is achieved if BABA stock closes near the $76 level at May expiration. The strike selection equates to the $76 support level.
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 firstname.lastname@example.org.