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Use Options To Cash In On The Volatility In Alibaba Stock

Alibaba (NYSE:BABA) has had a rough few months. And BABA stock’s losses are even uglier when compared to a broader market notching record highs seemingly every day.

Alibaba Group (BABA) headquarters sign located in Hangzhou China

Source: Kevin Chen Photography / Shutterstock.com

Falling alongside everything else is forgivable. But plumbing the depths when all your friends are getting high on profits is a fast way to make shareholders abandon ship. Today, I have a BABA stock trade that allows us to sidestep making a directional bet altogether and capitalize on the massive volatility instead.

Normally, I’m quick to pass on stocks with price charts like Alibaba for multiple reasons. First, trying to squeeze gains out of bear trades has been incredibly tricky over the past few months. The flood of liquidity created by record-setting fiscal stimulus and easy monetary policy coupled with vaccine hopes have bulls rampaging across the land.

Pullbacks have been few and far between, and when they do arrive, they’re ephemeral. We’re dealing with toothless teddy bears these days and until that changes I see little use in forcing short trades in the few tickers in downtrends.

Second, BABA stock has been hounded by headlines. As a result, its share price has suffered many overnight gaps since peaking last October.

The excess volatility increases directional trades’ difficulty because any whiff of positive or negative news can quickly trump whatever technical reason I used to enter the trade.

Take Wednesday, for instance. Despite the overall downtrend and bearish-leaning price action, BABA jumped as much as 7% after Wall Street Journal reported U.S.-based investors “won’t be banned from investing in Alibaba.”

Courting BABA Stock Volatility

Alibaba (BABA) chart showing high implied volatility

Source: The thinkorswim® platform from TD Ameritrade

One of the perks of trading options contracts is you can bet directly on volatility. Instead of obsessing about whether a stock will rise or fall, volatility trades focus instead on the magnitude of the move. “How far?” and “how fast?” become more pressing questions than “which direction?” But just as you wouldn’t want to buy or sell any old stock, you shouldn’t play volatility all the time.

Sometimes there’s no edge and the minimal reward isn’t worth the risk. Ultimately, this comes down to whether options are cheap or expensive. In the case of BABA stock, the premiums are pumped up or rich. And that more than anything has me eyeing a volatility play.

For curious readers out there, the primary reason for the elevated cost of options is the increased uncertainty surrounding all the news. Traders are willingly bidding the price of puts and calls higher. We’re going to use that to our advantage by selling them via an iron condor.

Unleash the Condor

The iron condor is a neutral, short volatility strategy that profits as long as it remains in a range. It will also benefit if volatility falls in BABA stock. Of all the stocks on my watchlist, Alibaba has one of the highest implied volatility ranks at the 54th percentile.

The Trade: Sell the Feb. $200/$195 bull put spread for 60 cents and sell the Feb. $270/$275 bear call for 60 cents.

The entire position should be entered for a net credit of around $1.20. Consider it a bet that Alibaba will sit between $270 and $200 at expiration. If it does,  you’ll capture the max gain of $120 per contract. The max loss, as well as trade cost, is $3.80. However, to incur the loss, BABA would need to rise beyond $275 or fall below $195. To minimize the loss, you could exit on a push to either level.

On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article.

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Article printed from InvestorPlace Media, https://investorplace.com/2021/01/use-options-to-cash-in-on-the-volatility-in-alibaba-stock/.

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