Shares of Alibaba Group Holding Ltd (NYSE:BABA) have been on a major move higher since making a low of $170.22 on April 25. BABA stock has now risen eight straight days and tacked on nearly 15% in that time frame. While earnings for Alibaba were certainly solid, the company didn’t exactly knock the cover off the ball. I think it has become a case of too far, too fast for BABA and expect a retracement of the rally over the coming weeks.
Alibaba reported earnings on May 4, with the company beating on both the top and bottom line. So while earnings and revenue were ahead of expectations, operating margin actually fell sharply to just 15% and is now at the lowest levels seen. This may explain the initial selloff in BABA stock following the earnings release.
Alibaba is also approaching a $500 billion market cap and still sports a rather healthy 50 P/E. High valuations and low margins always give me pause for concern.
Click to Enlarge From a technical perspective, Alibaba stock is getting decidedly overbought. Nine-day RSI is over 75 for only the third time in the past six months. The previous two times RSI exceeded 75 proved to be significant short term tops in BABA stock. Alibaba is also trading at nearly a 10 point premium to 30 day VWAP (variable weighted average price). Such large premiums have always been a reliable indication that the rally has gotten a little over exuberant.
Look for BABA to pull back towards VWAP over the next few weeks.
Click to Enlarge Implied volatility (IV) in BABA options is at the 33rd percentile, meaning option prices are getting fairly cheap. This favors long volatility strategies when constructing trades. Interesting to note that the option skew now has flipped, with out-of-the-money calls trading at a higher IV level than similar out of the money puts. Normally it is the puts that carry a higher level of implied volatility. This is yet another sign that the upside euphoria may be close to reaching a peak.
So to position for a pullback in BABA stock, a put diagonal trade makes sense.
BABA Stock Trade Idea
Buy BABA June $190 puts and sell BABA May $185 puts for a $4 net debit.
Maximum risk on the trade is $400 per spread. Ideally BABA closes near the $185 at May expiration to realize the maximum gain. The trade is net short 22 deltas at inception, which equates to being short 22 shares of stock.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility
