Few stocks have been as successful as that of Alibaba Group Holding Ltd (NYSE:BABA). It is up 100% year-to-date which is double that of other high profile winners even Amazon.com, Inc. (NASDAQ:AMZN).
This past summer, BABA management promised big things and they delivered. The proof is that even after a huge run, the stock is not bloated.
BABA has a price-to-earnings ratio of 49. This is one fifth that of AMZN. Don’t get me wrong, I am not saying it’s cheap but with strong growth and good margins, the price is worth it.
So I am very confident that under the current macroeconomic conditions I want to own Alibaba shares, especially if at a discount.
First of all, it is evident that the bulls are still in control of the stock market. Bears cannot maintain a selling spree more than a few hours. Secondly, BABA stock has just corrected almost 10%.
But it still remains inside a three-month channel. So there is a high chance it bounces instead of breaking down and I want to profit from it.
Click to Enlarge However, I do have to recognize that if BABA stock falls below $172 per share, it could invite momentum sellers to target the low $160’s. This is not a forecast but I have to know it exists. Luckily, using options I can make room for it.
No, I won’t buy the stock at face value. I need more room for error. So I will use options to sell downside risk against support. I believe more strongly in the value below than in the upside targets. With options I can tip the odds of winning in my favor.
Expectations on Wall Street cannot be much higher than they are for Alibaba stock. Almost all analysts who cover the stock have a strong buy bias on it. This leaves plenty of room for disappointment. However, I am not too worried about in the current environment. Online spending is afoot and proof to it is Singles’ Day in China which generated 25 Billion in sales in one day. This is proof of the potential inside BABA stock.
BABA Stock Trade Idea
The Trade: Sell the Jan BABA $150 put for $1. Here I have 85% theoretical odds of winning. Otherwise I own the shares and will accumulate losses below $149.
Selling naked puts carries big risk, especially for a three-digit stock. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the BABA Jan $155/$150 bull put spread. Here the risk is smaller yet the rewards would be 8% in yield. Compare this with risking $175 per share and without any protection expect an 8% rally just to match the performance of the spread.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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.
