Alibaba (NYSE:BABA) stock has been on a long 20% slide since its June highs. This week, management reported earnings and the reaction was violent. First there was a negative knee-jerk dip to $170 per share in after-hours activity, but it reverted sharply higher.
Alas the jubilation didn’t last, as the stock tumbled 3% in open session trading.
BABA delivered a strong earnings report. They beat on sales but missed on earnings. Also the stock drifted lower on chatter of one-time charges and renewed talks of rising tensions with China, and on the day of another $16 billion in tariffs.
To me this changes nothing for Alibaba stock. These headlines are short-term in nature and do not negate the facts that this is a money-making machine. And therein lies the opportunity.
Management blew away the revenue expectations on the back of strong e-commerce activity. This includes their foray into the cloud, which currently contributes but a small portion so it has a lot of potential. The point is that they are doing the right things and those require some spending. Hence, a miss on profitability doesn’t worry me at this stage.
Even though I am convinced that the BABA stock is viable, I can’t trust the upside potential to materialize for as long as we have China tariff headlines looming. So instead of buying the shares outright and risking $174 per share with no room for error, I will use the BABA options. There, I sell puts into what others fear to generate income without any out-of-pocket expense.
Fundamentally, it has a trailing price-to-earnings ratio of 46, which sounds high. But it pales when you compare it to Amazon (NASDAQ:AMZN) which is also a momentum growth stock. BABA is 70% cheaper. Even then, as long as they continue to grow this fast, I don’t worry as much about margins.
The bottom line is that BABA is successfully executing on plans and they are expanding into the right areas. To do that they have to spend a bit more than normal, so yesterday’s scare was misplaced.
Technically, BABA stock had a pivotal 2017 when management made a strong statement. Investors believed them and pushed the stock to a new level. This year the dips have challenged the necklines from which they broke out several times. Although this is good news and builds confidence in support, it also makes them crucial to hold. Losing footing around $165 per share could bring another 10% dip from there. This is one scenario not a forecast.
BABA Stock Trade Ideas
The Bet: Sell the BABA DEC $145 put and collect $2.50 per contract to open. I have a 85% theoretical certainty so that I retain maximum gains. Otherwise, I will accumulate losses below $142.50.
Selling naked puts carries big risk, especially for a momentum stock like BABA. For those who want to mitigate that, they can sell a spread instead.
The Alternate Bet: Sell the BABA DEC $145/$140 credit put spread which would deliver over 15% in yield but with much smaller risk. Both setups have about the same odds of success and neither requires a rally to win.
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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.