Alibaba (NYSE:BABA) is refusing to participate in the year-end run for stocks. It’s one of the few popular stocks that’s falling while others are flying. Today we’re exploring the weakness in BABA stock and carving out a pair of trade ideas for bulls and bears.
Christmas came early for equities this year. Pfizer (NYSE:PFE) played Santa’s role and is flying around the world, delivering vaccines to combat the novel coronavirus. Its Nov. 9 announcement spelled the end of the past century’s nastiest pandemic and the beginning of a new bull market. Nowhere have the effects been felt more than in small-cap stocks.
Following months of underperformance, the Russell 2000 is rocketing higher to make up for the lost time. November was its best month in history with a gain of 18.2%. December has continued the rocket ship rally, tacking on another 8%.
What does this have to do with Alibaba, you ask? It provides a perfect contrast to compare the Chinese giant’s recent performance against. While small-caps have been soaring, BABA stock has been sinking. Even if I had used a more similar comparison, such as the Nasdaq or the tech sector, you’d still discover that Alibaba has fallen far out of favor.
BABA Stock: A Closer Look at the Chart
It’s a shame, really. While shareholders across the land celebrate the post-November ramp in equity prices, Alibaba owners have had to wrestle with a bear market. From peak-to-trough, their beloved stock’s drawdown eclipsed the 20% threshold. However, in fairness to the stock, today’s commentary is based heavily on anchoring it to its October peak. If we focus instead on the year-to-date performance, things turn decidedly more bullish. Even with the recent whack, BABA stock is still up 18% for 2020.
So it’s not all bad.
For the longer-term bullish trend to resume, however, it must overcome the short-term weakness. Last month’s disappointing earnings report sparked a wave of selling. Distribution days multiplied as prices sank beneath the 20-day and 50-day moving averages. Since then, we’ve been unable to climb back above the 20-day moving average. Every attempt has been summarily rejected. The last beatdown struck on Friday as buyers were once again turned away.
In the short-run, the 20-day moving average is my line in the sand. Remain below it, and I continue to be pessimistic on BABA’s price trajectory. Vault above it, however, and I’m more open to long trades.
Ultimately, however, it’s the 50-day moving average that demands the most attention. It currently sits near $280 and is the level that needs to be breached if the longer-term uptrend is going to be restored.
What I like about the current positioning of the stock is the number of trades we can craft around the setup. Let’s take a closer look at two of my favorite.
Two Trade Ideas to Consider
If Friday’s rollover has you itching to join the sellers, then I prefer bear call spreads. The strategy consists of selling out-of-the-money calls in anticipation of prices remaining under pressure. As long as the calls remain out-of-the-money, they will expire worthless, allowing you to pocket the premium you were paid upfront.
Bear Call Trade: Sell the Jan $280/$285 call vertical for 80 cents.
The max gain is 80 cents, and the max loss is $4.20. To minimize the damage if wrong, exit if prices rise above $280.
For bulls who believe that the longer-term uptrend will ultimately prevail, I suggest waiting for a push above the 20-day moving average at a minimum to confirm buyers are returning. When that happens, purchasing 3-month bull calls will give the stock plenty of time to make a run back toward $300.
Bull Call Trade: Buy the March $280/$300 call vertical.
The current price is $4.85, but it will be more expensive once the confirmation arrives. Your max loss is limited to the initial cost, and the max gain is capped at $20 minus the trade cost.
On the date of publication, Tyler Craig held a LONG position in PFE.
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