Months ago, I saw a technical bullish setup coming in Alibaba Group Holding Ltd (NYSE:BABA) and it didn’t disappoint. The 50% rally was fierce. So I definitely underestimated its magnitude.
Now I see a similar setup where the BABA stock price range has been tightening and a move coming. Even though the direction of which is not clear yet, in this uber-bullish equity market, it’s not likely to be down.
So my thesis today thesis is simple. I want to bet that the BABA bears will lose again. I want to do it in a way where I have no out-of-pocket expense.
No, I won’t buy BABA stock outright. I’d rather bet on proven history, then on upward speculation. So I will sell downside risk against perceived value. The trick is just us to find a level of support that will hold should price move against me.
Alibaba isn’t cheap, with a 56 trailing price-earnings ratio. Especially when you consider that its P/E is equal to that of Microsoft Corporation (NASDAQ:MSFT) and Alphabet Inc (NASDAQ:GOOGL) combined. BABA bulls are definitely setting expectations high and any hiccup there is a potential liability to the stock price.
But it’s not bloated either considering the growth they deliver. Furthermore, management told us that things are going so well for them that they’re going to over-deliver on their promises. It’s hard to short that kind of conviction from a well-known leader like Jack Ma. So shorting it this year has been financial suicide. I think this will continue throughout the year. Technically, the squeeze is here and the move is coming.
This company is a momentum stock. Which means that it is difficult to trade the traditional way. On the way up it rises so fast that it appears like it’s due for a pullback at any time, thereby keeping a lot of investors out. If I use options, then I don’t have to worry about timing as much.
But it doesn’t mean I go into it willy-nilly, but I can afford to be somewhat imperfect with my entry points.
Click to Enlarge If I have any worries it would be from expectations. Analysts are unanimous in their BUY recommendations of Alibaba stock. This leaves only room for downgrade surprises.
Eventually, they will come. But meanwhile, I trade the price action.
BABA Stock Options
The Bet: Sell BABA stock Dec $130 put and collect $1 to open. Here I have 90% odds that price will stay above my strike. Otherwise, I have to own the shares at that price and accrue losses below $129.
Selling naked puts can be daunting and is not suitable for all traders. I can mitigate the risk by selling spreads instead. By buying an equal number of puts below the ones I sell I limit the maximum potential losses.
The Alternate Bet: Sell BABA stock Dec $135/$130 credit put spread where the risk is much smaller. But if successful, the spread will yield 10%.
Consider this versus risking $171 per share now and without any room for error hope that the stock will not fall. With my setup, BABA can fall 20% and I still keep maximum gains.
Since there are no guarantees when investing in the stock markets, I never bet more than I am willing to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
