I still may not know “Jack” about the financial intricacies and inner workings massive Chinese e-commerce operator Alibaba Group Holding Ltd (NYSE:BABA), but I do know price charts and options. And based on those, BABA stock is setting up nicely for the bulls.
They say timing is everything, but if you’re an options trader, the strategy is equally important. As this relates to Alibaba, we accomplished both in spades when we wrote about the stock back in mid-March.
In a nutshell, shares of Alibaba were breaking out of a technical base in the absence of news. In fact, propagandist headlines warning of the bearish impact of rising U.S. interest rates on Chinese equities, as well as an economic conundrum tied to growth stabilization and of China’s own making, were all the rage.
The narrative at the time made BABA stock a seemingly poor bull play. Yet fast forward to today, and shares are up 14% and handily outperforming U.S. markets — as well as the iShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI), which is up less than 2%!
So what happened?
It’s hard to say for sure, but the importance of a specific theme tends to wear off over time. As InvestorPlace’s Tom Taulli recently discussed, maybe traders decided over the last two months to optimistically embrace Alibaba’s massive appeal as “China’s Amazon.”
But where does this leave Alibaba for now? Well, following its staunch rally, it’s probably time for a truce between the bulls and the bears.
BABA Stock Chart
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However, I expect a period of profit-taking to emerge in the near-term.
Stochastics have been overbought for an extended period, while shares have remained glued to the upper Bollinger Band the past couple months. As this action coincides with a breakthrough of Alibaba’s all-time high sent in 2014, I’m anticipating a modest bit of technical backing and filling before a cup breakout reveals itself.
How to Trade Alibaba
I want to approach BABA stock as a pullback play with a put credit spread. But in this case, it’s not that simple, as Alibaba reports fiscal fourth-quarter earnings later this week.
Earnings could act as a breakout catalyst regardless of shares’ overbought readings. Because of this, and because I’d ideally like to buy on weakness — but don’t want to get left out of a rally — I suggest a modified fence.
With Alibaba at $120.34, I suggest selling the May $116/$115 put spread and buying the May $125/$126 call spread, which is priced for even money.
If BABA were to suffer a bearish move or simple profit taking, the sold put spread would have you positioned to buy shares at $116. That’s a decent discount to Friday’s closing price, but you could score an even better deal if Alibaba trades well beneath the purchased and protective $115 put.
Ultimately, you only put $1 at risk. Hence, if BABA was at $110 on Friday and you’re willing to bet on weakness, the net effect would be buying shares at $111 after accounting for the loss on the vertical.
On the upside? If shares of BABA break out, you’ll own the $125/$126 bull call spread for free. That means if Alibaba rallies less than 4% and above the $126 call, the position profits $1.
This strategy isn’t a free lunch. But if you’re receptive to buying BABA on weakness with defined risk — and simultaneously have some concern about being left out of a bullish reaction — this trade is worth your time.
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.
