It’s been a less-than-magical ride for bulls in Alibaba Group Holding Ltd (NYSE:BABA), but shares appear ready to takeoff once again. To secure a safer passage, a low-risk BABA spread in lieu of stock looks like the right way for bulls to hop on board. Let me explain.
The past couple months have been difficult for BABA shareholders. Since hitting a high near $110 back in late September, Alibaba stock has been stripped of 20%.
Much of the pressure in shares of Alibaba can be attributed to currency devaluation of the renminbi or yuan. Increased confidence of higher U.S. interest rates and specter of a trade war between the world’s largest and second biggest economies are largely behind the weakness in China’s currency.
Sales at Alibaba are mostly domestic, so that’s not the real issue for BABA and its investors. The real impact is the currency conversion due to the stock’s status as an American Depository Receipt, or ADR.
As an ADR investment, currency implications occur as Renminbi-based profits are translated back into the US denominated ADR. Thus, for investors in BABA stock, a weak Chinese currency relative to the dollar, all else being equal, means shares will lose value when that relationship weakens.
The good news according to analysts at MKM Partners, is the foreign exchange pressure is due for a rest. Even better, the firm notes if history is any indicator, shares of BABA are poised for a meaningful rally as the yuan stabilizes from here.
Given a price chart that also looks supportive, history may not repeat exactly, but its ability to rhyme looks reasonable.
BABA Stock Daily Chart
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For their part, Kynikos appears to still be betting against BABA. Technically, though, and as discussed prior, the chart has continued to make the bullish case for shares of Alibaba.
Since breaking above $83 back in July, BABA has put together an intermediate uptrend from its corrective October — February lows. Currently, countertrend weakness of the past several weeks is offering up the opportunity to go long BABA with multiple chart supports to back the decision.
With shares of BABA about 1% removed from its lows, a small double or triple bottom pattern has emerged. Zone support from roughly $86 to $90 holds a couple Fibonacci retracement levels, 200-day simple moving average, a bullish gap fill and key breakout pivot from last fall as support.
BABA Stock Bullish Butterfly Spread
Given I like the idea of buying zone support, but don’t enjoy the idea of being left holding the bag in the event Kynikos is proven right in the near-term, the January $92.50/$95/$97.50 long butterfly is attractive.
Priced for around 25 cents, the out-of-the-money spread’s position allows it to act as a bullish surrogate to other strategies, but at a vastly reduced cost in case BABA doesn’t rally and continues to fall.
The big risk or compromise for a butterfly position is if BABA moves too strongly in the intended direction. Because of its design which utilizes competing vertical spreads, the debit paid will be lost above the highest strike at expiration. Also, gains approaching the max payoff are very slow to be realized.
The good news is an upside loss in BABA would require a fairly hefty 9.5% lift above current prices in order for the butterfly to lose. Additionally, a very small debit, the butterfly’s fairly nice-size profitability range of $92.75 to $97.25 and potential max profit of $2.25 at $95 trump those other compromises, which are always a part of trading.
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.
