In the last 10 years, e-commerce has become the way that most of the developed world does business and the adoption rate will continue to be exponential. Perhaps this is a trail that Amazon (NASDAQ:AMZN) blazed, but now we have hundreds of other companies chasing after it.
Alibaba (NYSE:BABA) is one of the leaders in the field and BABA stock has been an excellent trade. However, in 2018 we have a tariff war brewing between the U.S. and the world. President Trump is trying to negotiate better terms for U.S. goods into places like China.
This has hurt BABA stock sporadically as headlines flare up. So far, dips have been opportunities to go long BABA, so I come into this trade with profits in pocket from the last go-round and therein lies the same opportunity.
Fundamentally, Alibaba stock is not cheap as it sells that 50 price-to-earnings ratio. But this is a growth company and from that perspective, I don’t expect much on profitability for as long as they deliver on growth. Management has been executing on its plan very well and Wall Street has rewarded it over all.
Although year-to-date BABA stock has been flat, over the past 12 months the stock is up 30%, which is in-line with Apple (NASDAQ:AAPL) and the PowerShares QQQ Trust ETF (NASDAQ:QQQ). So there are no issues specific to BABA fundamentals holding the stock back this year, but merely rhetoric from trade war headlines with China.
Technically, for almost a year, the stock has been bouncing off the $170-per-share area on every selloff. It is now approaching that level again and I do expect it to hold through this year. Global fundamentals are still conducive to better business results provided the risk looming from these trade war threats abate.
No, I will not buy Alibaba shares outright and risk $180 without any room for error. Instead, I will use options where I can build a buffer zone between the current price in my level of risk. This is the definition of being cautiously optimistic.
Today’s trade setup makes me long Alibaba stock, but with a position that takes another correction lower and still retain profits. I don’t even need a rally to profit, but if one comes, then my greens develop quicker.
BABA stock is back to where it was before its most recent earnings report. The reaction to that report was very positive and the stock rallied 16% off the headline. Alas, for the past two weeks, it has priced it out almost completely.
So now it’s back to that same pivot zone and these tend to be support on the way down. However, with every test, the bulls run the risk of losing the floor and if that happens, the stock could fall below $160 per share. Although this is not a forecast, it is a scenario of which I need to be aware.
How to Deal With BABA Stock
The Trade: Sell the BABA JAN 2019 $135 naked put. This is a bullish trade, where I collect $2.50 to open. Here I have a 85% theoretical chance of success, but if the price falls below my strike, then I accrue losses below $132.50.
Selling naked puts carries big risk, especially for a biotech stock like Alibaba. For those who want to mitigate the risk, they can sell a spread instead.
The Alternate Trade: Sell the BABA JAN 2019 $135/$130 credit put spread, where there are about the same odds of winning, but with much smaller risk — the spread would yield 10% if successful.
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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.
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