These are amazing markets we are experiencing on Wall Street this year. For example, yesterday the S&P and the NASDAQ were up .7% and 1.3% respectively. Alibaba’s (NASDAQ:BABA) had a decent day up only .4%, but this year Alibaba stock too has been a super star. On the other hand, the small-caps were down fractionally for the day. Investors are swapping risk back and forth between mega-cap technology stocks and the small-cap sectors.
Thursday Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) were up 3.4% and 6.4%, respectively, while the iShares Trust – iShares Russell 2000 ETF (NYSEARCA:IWM) could not hold zero. Year-to-date Alibaba stock is no slouch up 21%. This is inline with the Invesco QQQ Trust, Series 1 (NASDAQ:QQQ).
Overall investors have been unwilling to be bearish equities for more than a few hours. Even when they do sell some they choose to rotate positions into other sectors or asset classes. Clearly there is one bucket of money and investors are not willing to net sell out of it.
Wall Street investors want to remain invested in spite of all the risks that loom. Today we will look at the opportunity in BABA within that market dynamic.
The Bulls Are in Charge of Alibaba Stock
Alibaba stock lost a quarter of its value from the quarantine crisis but quickly double-bottomed and recovered all of it in about a month. Since then it has successfully established a strong base around $280 per share, from which it rallied 20% in June and into July.
However, it is still lagging Apple and Amazon (NASDAQ:AMZN), to name two other super star mega-cap stocks, by a mile. Soon the company will report earnings and management will have the opportunity to make the case for higher stock price levels.
Fundamentally, Alibaba is not dirt cheap because it has a 33 price-to-earnings ratio and 9.5 times its full-year sales. This is about the same as Facebook, Alphabet (NASDAQ:GOOGL,NASDAQ:GOOG), and Apple. This is cheap enough that this alone is not reason to sell it. Those who want to own the shares for the long-term can do so with a clear conscience.
On the other hand, this is also not the time to start full sized positions because this is not a clear point of entry. We are near all-time highs with the overall economy still in grave danger. Taking full sized positions all at once carries tremendous risk and leaves little room to manage it. Alibaba stock also carries extra risk from the renewed antagonistic rhetoric between the White House and China over de-listing Chinese companies from U.S. markets.
Think Outside of the Box
Alternatively, investors can seek strategies from the options markets because they allow for creating positions with buffer zones. For example, I can sell the October $210 put and collect almost $3 per contract. The advantage of doing this over buying shares is that here I don’t even need a rally to profit. I retain my maximum gains even if the stock falls another 20%. The break even on this trade is at $207 per share.
Compare that with having to buy BABA shares now and hope for a rally in order to profit and no wiggle room. The two strategies can work together, though. Investors can start by selling the puts to get long now, then as the stock stabilizes, they take the second tranche by buying shares.
Options provide great tools to manage risk for new positions and protect current ones with very little out of pocket expense. All investors should learn the basics so they can defend against impending Wall Street debacles. But that is a conversation for a different write-up.
Stick With What’s Working
Back in early June I shared a note with a similar strategy because at the time bullish conviction was low. I suggested selling puts to generate income out of thin air and it worked. Today is merely a rinse-and-repeat setup because at these levels Alibaba stock has more downside risk than upside opportunity.
Sure, it can rally, but it is definitely not an obvious place to start longs in size. It recently had a strong push higher, one that I also noted in June. The breakout over-delivered on its technical target and the sellers were able to squash it down 10% almost twice. So far the buyers are defending the area well but are under pressure even this morning.
This push-pull situation makes for a poor reason to load up longs. Alibaba stock is a hot stock near its highs and going into a binary earnings event. This is never a clear point of entry because investors are unpredictable with their reaction to the headlines. Using the aforementioned options strategies allows for those who cannot wait to get long now with caution.
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.