After making a new all-time high at $177 on Aug. 24, shares of Alibaba Group Holding Ltd (NYSE:BABA) have come crashing back to reality. BABA stock dropped over 12 points, or 7%, in the past four trading days before finding support Tuesday.
While certainly not a raging bull (but no longer as bearish), I expect Alibaba shares to consolidate around current levels over the next few weeks.
In my previous post on Alibaba from Aug. 24, I laid out a guardedly bearish case for Alibaba over the coming weeks, predicated on the notion that shares had come too far, too fast. This proved to be the case, as BABA did drop the aforementioned 7% since then. However, now that Alibaba’s stock price has realigned to a more realistic level, my bearishness has diminished greatly.
Price does matter.
InvestorPlace contributor Joseph Hargett does an excellent job of drilling down some of the fundamental reasons to own BABA stock for the long run. Certainly the latest earnings report was impressive, beating on both the top and bottom lines. Traders, however, tend to focus more on the shorter-term technicals rather than longer-term fundamentals, especially in this market environment.
That’s OK. Alibaba’s charts are looking pretty good at current levels.
As seen in the chart, Alibaba stock came down to the post-earnings breakout gap at $164 and held. The price action yesterday was particularly telling, with BABA trading down to a low of $164.35 before rallying sharply to close more than 3 points off the low at $167.41. This type of reversal day is many times emblematic of a bottom in the stock, especially at such a critical support area.
Major support is looming at the $160 level, which previously had proven to be staunch resistance before the earnings breakout. Given how impressive the earnings were — as discussed in depth by InvestorPlace contributor Vince Martin — I would expect the $160 level to hold for the foreseeable future.
To position for a period of consolidation in BABA stock, an out-of-the-money put credit spread makes sense.
Trade Idea on BABA Stock
Buy the Sep $157.50 puts and sell the Sep $160 puts for a 40-cent net credit.
Maximum gain on the trade is $40 per spread with maximum risk of $210 per spread. Return on risk is 19.04%. The short $160 strike is positioned right at the $160 major support level and provides a 4.42% downside cushion to the $167.41 closing price of Alibaba stock.
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 timbiggam@gmail.com.
