Alibaba (BABA) stock is in a serious downtrend and was a bearish candidate that came up on one of my screeners for being rated a Strong Sell with a 100% Sell rating.
Today, we’re going to look at a Bear Put spread trade that assumes Alibaba will Continue declining over the next month or so.
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A Bear Put spread is a bearish trade that also benefits from a rise in implied volatility.
The maximum risk for a Bear Put spread is limited to the premium paid while the maximum potential profit is also capped.
The maximum profit is equal to the width between the strikes less the premium paid.
Alibaba Bear Call Spread
To create a Bear Put spread, we buy an out-of-the-money put and then sell another put further out-of-the-money.
Buying the December 18th put with a strike price of $95 and selling the $85 put would create a Bear Put spread.
This spread was trading for around $2.72 on Tuesday. That means a trader buying this spread would pay $272 in option premium and would have a maximum profit of $728.
That represents a 267.65% return on risk between now and December 18 if BABA stock falls below $85.
If Alibaba stock closes above $95 on the expiration date the trade loses the full $272.
The breakeven point for the Bear Put spread is $92.28 which is calculated as $95 minus the $2.27 option premium per contract.
Company Details
The Barchart Technical Opinion rating is a 100% Sell with a Strengthening short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
Alibaba Group Holding is one of the leading e-commerce giants in China. Over the last few years, the company has transformed itself from being a traditional e-commerce company to a conglomerate that has businesses ranging from logistics and food delivery to cloud computing. Alibaba Group is represented by three businesses' Alibaba.com, Taobao, and Tmall. The company's businesses account for more than half of all online retail sales in China, which is one of the world's fastest-growing e-commerce markets. Taobao is one of Alibaba Group's most profitable marketplaces that generates for more than 80% of its sales, thanks to soaring demand for high-quality imported brands in China.The company is well positioned in the New Retail space. In this space, it aims to bring together digital payments, e-commerce, food delivery and other parts of the business into one big ecosystem. The ubiquity of smartphones and evolution of physical and online commerce are helping the company to gain momentum in this space.
Conclusion And Risk Management
One way to set a stop loss for a Bear Put spread is based on the premium paid. In this case, we paid $272, so we could set a stop loss equal to the 50% of the premium paid, or a loss of around $136.
Another stop loss level could be if the stock broke above $110.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not directly have a position in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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