Shares of Alibaba Group Holding Ltd (NYSE:BABA) have certainly felt the market wrath over the past several trading sessions. After trading at a new all-time high of $206.20 at the end of January, BABA has fallen over 12% in just the past three days following earnings.
While Alibaba stock may have overshot to the upside during the previous rally, I think the veracity of the latest selloff is also getting a little overdone. I would be a buyer of BABA on further weakness.
Alibaba reported mixed earnings on Feb. 1. EPS was a slight miss, coming in at $1.63 versus consensus estimates of $1.65. Revenues, however, beat handily with sales of $12.76 billion exceeding analyst expectations of $12.12 billion. Most importantly, the company upped 2018 revenue guidance from 49%-53% percent to 55%-56%.
While still not a value stock by any stretch, a 12% drop in the stock on a 1% earnings miss most assuredly makes the valuation more attractive.
Click to Enlarge The plunge in BABA also is looking better from a technical perspective. Alibaba stock is fast approaching the critical support level at $170 which has held on previous occasions. BABA is also getting oversold on a 9-day RSI basis with readings that have marked significant lows in the past. I expect shares to find solid support on any further significant weakness.
The recent carnage in Alibaba is having a decided effect on BABA options. Implied volatility (IV), which normally lessens after earnings, is now at the 89th percentile. This means option prices are comparatively expensive, making option selling strategies the preferred trade structure.
So to position to be a buyer of BABA on further weakness, an out of the money put credit spread makes intuitive sense. Credit spread strategies also allow traders to collect premium now while waiting to be a buyer later.
BABA Stock Trade Idea
Buy the BABA Feb $165 put and sell the BABA Feb $170 put for a 75-cent net credit.
Maximum gain on the trade is $75 per spread with maximum risk of $425 per spread. Return on risk is 17.64%. The short $170 strike is positioned right at the critical support level and provides a 5.83% downside cushion to the $180.53 Monday closing price of BABA.
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 email@example.com.