Shares of Alibaba Group Holding Ltd (NYSE:BABA) closed at an all time high Friday at $191.19. This follows an impressive 26% run up from the Aug. 11 lows and an even more impressive 117% gain since the beginning of the year for BABA stock.
While Alibaba is unquestionably the dominant player in the Chinese e-commerce space, the stock has come too far, too fast and is due for a period of consolidation.
A quick look at valuation levels for BABA stock certainly should give investors pause for concern. Alibaba is definitely not a value stock, sporting a extremely rich current P/E ratio of 53.6. Even the forward P/E of 37.3 is still decidedly in nosebleed territory, far eclipsing the 21.2 forward P/E for the S&P 500. The current price-to-sales ratio of 16.5 borders on the ludicrous, especially given that BABA has a market cap fast approaching half a trillion dollars.
Alibaba now has 488 million annual active users, a staggering number indeed. Revenues for last quarter beat at $8.285 billion versus consensus of $7.78 billion. Growth to-date has been torrid, to say the least. Growth going forward, however, will necessarily begin to slow simply due to the law of large numbers. Let’s not forget that BABA is already priced for hyperbolic growth with that extreme 16.5 P/S ratio.
A technical look at Alibaba shares also points to a likely slowdown in the most recent rally. BABA stock is now overbought on a five day RSI basis with a reading over 70.
Previous instances when shares where this overbought coincided with short-term tops in the stock. The $191 level also could prove to be significant resistance for BABA stock going forward.
Alibaba options are currently trading in the 46th percentile of implied volatility (IV) over the past year. This means option prices are carrying a decent amount of premium, making option selling strategies still viable.
So, to position for a stall out in the recent BABA rally, an out-of-the-money bearish call spread trade makes sense.
BABA Trade Idea
Buy the BABA Dec $202.50 calls and sell the BABA Dec $200 calls for a 40 cents net credit.
The maximum gain on the trade is $40 per spread with a maximum loss of $210 per spread. Return on risk is 19.05%. The short $200 strike price provides a 4.6% upside cushion to the $191.19 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.
