Just three weeks ago we wrote about the attractiveness of this stock, but warned of near-term volatility events at the start of November. One of those events has played out, drawing the share price lower. However, we believe the shares are now trading too low, and they could be driven even lower in the days ahead (as fearful investors panic). These conditions have given rise to this attractive options trade. The trade sounds complex (i.e. “bullish vertical put spread”), but it’s not. It puts attractive upfront premium in your pocket today, it gives you a chance to pick up shares of this attractive stock at a lower price, and it gives you a little insurance on the downside (i.e. your max loss is limited). We believe this is an attractive trade to place today—and potentially over the next few trading sessions—as long as the price doesn’t move too dramatically before then.
Alibaba (BABA)
The stock we are referring to is Alibaba (BABA)—a Chinese internet juggernaut that trades in the US as an ADR and is often referred to as “the Amazon of China.” Here is our very detailed report (and here) from three weeks ago, in which we described the upcoming Ant Group IPO as a volatility catalyst. BABA has a 30% stake in Ant Group, which was supposed to begin trading publically via an IPO tomorrow (initial public offering). However, the Chinese regulators halted the IPO, and the share price of Alibaba probably should not have fallen as much as it did (almost 10%), and it may fall more in the days ahead. Alibaba is reported to have a 30% stake in Ant Group. Alibaba’s market cap is ~$778 billion (after yesterday’s big price decline) and Ant Group was recently valued at about $315 billion. A 30% stake means Ant Group represented ~12% of BABA’s market cap. It fell almost that much yesterday (even though Ant Group still has tremendous value), and it may fall more in the days ahead. This has created the attractive income-generating options trade in this report.
(Purple Line: BABA)
The Trade: “Bullish Vertical Put Spread” on BABA
Sell AND Buy Put Options on Alibaba (BABA) with a strike price of $265.00 (sell) and $200.00 (buy), and an expiration date of December 18, 2020, and for a net premium (upfront cash in your pocket) of at least $8.57 (or $857 because options contracts trade in lots of 100). Your broker will make you keep $6,500 cash on hand (($265 - $200) x 100. The trade generates ~13.2% of extra income over the next 44 days (this is a lot!). And this trade not only generates attractive income for us now, but it gives us the possibility of owning shares of attractive BABA at an even lower price if the shares fall even further than they already recently have, and they get put to us (and we’d be happy to own BABA, especially if it falls to a purchase price of below $265 but above $200 (if it falls below $200 we’d take the cash difference between our $100 strike put and the market price at expiration—this is basically insurance)). The trade may sound complicated, but it’s not, and your broker likely makes all the calculations and execution easy as you can see in the graphic below.
Your Opportunity:
We believe this is an attractive trade to place today and potentially over the next few days as long as the price of BABA doesn't move too dramatically before then, and as long as you’re able to generate premium (income for selling, divided by put sale strike price) that you feel adequately compensates your for the risks (currently 13.2% over the next 44 days).
Our Thesis: Alibaba (BABA)
Our thesis is simply that we believe BABA is an attractive stock, regardless of what happens with Ant Group, and you can read our previous full report here. Basically, BABA is a very attractive long-term investment trading an a very attractive near-term price.
Important Trade Considerations:
A few important considerations for this trade are the upcoming earnings announcement (tomorrow), Singles Day (Nov 11th) and the outcome of the Ant Group IPO as well as the outcome of the US elections (as we described in our earlier report). Yet despite all of these uncertainties (which actually work to increase the upfront premium income available on this trade) we believe Alibaba remains a very attractive long-term business, and it is trading at a very compelling price (and even more compelling if the shares get put to us at $265).
Conclusion:
When fear and volatility spike, so too does the upfront premium income available in the options market. In the case of Alibaba, there are a lot of near-term unknowns that are causing fear and thereby increasing the premium income available on this trade. However from a long-term standpoint, Alibaba remains a very attractive long-term business and it currently trades at a very compelling valuation. If these shares get put to us at $265—that’s great—and we look forward to hanging on for the long-term. And if they don’t get put to us, we’re happy to keep the upfront premium income that this trade generates for us (we get to keep that income, no matter what, and in this case it is a lot!). Furthermore, not only do we have a little insurance on this trade (we put/sell the shares at $200 if they fall below that level before the options contract expires), but the insurance piece also lets us enter this trade with a lower amount of cash set aside than if we just sold naked puts. The big risk is that the shares fall all the way below $200 and we sell at that level. However, there are lots of ways to win. We like this trade and we like Alibaba as a long-term investment.