Shares of Alibaba Group Holding Ltd (NYSE: BABA) rallied over 2% yesterday, closing at an all-time closing high of $210.86. The latest pop in BABA stock was fueled by positive comments from Stifel analyst Scott Devitt who expects Alibaba to will continue to benefit from increasing online/mobile shopping penetration, offline/online retail integration and China’s emerging middle class.
While BABA still may have room to run in the longer term, in the short term I feel the stock has come too far, too fast. Given the recent red-hot rally, it is healthy for BABA stock to pull back and consolidate.
Alibaba is starting to get to an extreme on a fundamental basis. The current P/E is over 50 once again and at the highest level since September 2016. A look back on the chart shows that BABA stock made a significant intermediate-term top in September of 2016. Other metrics, such as Price/Sales (15.2) and Price/Cash Flow (28.3) are also fast approaching levels that normally warrant caution. At some point, valuations do matter.
BABA stock is now up over 25% in less than two months since making a low of $166.64 on April 25.
While Alibaba did close at an all-time high yesterday of $210.86, it is important to note that it failed to get past the all-time intraday high of $211.70 from June 5. Any failure at these lofty levels could easily lead to some quick profit taking and a move back towards the previous highs of $205 from late January. Given the magnitude of the recent rally, I think probabilities favor a pullback.
Perhaps most importantly, implied volatility (IV) is trading at the lowest levels of the past year. This means option prices are the cheapest they have been over that time frame. So to position for a short-term pullback in an overextended BABA stock, a put diagonal trade makes intuitive sense. The trade structure is long vega, meaning it benefits from a general rise in IV. Plus I always like the combination of comparatively cheap options and a comparatively expensive stock.
BABA Stock Trade Idea
Buy the BABA July $210 puts and sell BABA June 29 $200 puts for a $4.50 net debit or better.
Maximum risk on the trade is $550 per spread. Ideally BABA stock closes near the $205 point on June 29 expiration to realize the maximum potential gain. The trade is 18 deltas net short at inception, or the equivalent of being short 18 shares of stock.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility/
