$BABA Vol Steep Have You Many Fills

by Enis September 29, 2014 12:16 pm • Commentary

Today is the first day of trading for BABA.  The company sold shares to fund managers (let’s be honest, it was not really an initial “public” offering) at $68 on the evening of September 18th.

Since then, BABA has traded as high as $99.70, on the first day of trading, and as low as $86.62 on Sept 23rd:

BABA intraday chart, courtesy of Bloomberg
BABA intraday chart, courtesy of Bloomberg

The stock’s range of about 14% for the first seven days of trading since its IPO is lower than most of the high profile internet IPOs (FB, TWTR, LNKD, etc.) of the past few years.  Granted, BABA’s market cap is much larger than the other stocks, so the investor base is more diversified, and it takes a lot more size to move the stock.

With that as the context, it’s noteworthy that BABA volume has steadily dropped off over the past week, one possible sign that the big fund investors are satisfied with their current BABA allocations and have started focusing on other areas (though today’s volume is on track to outpace the past few days):

BABA price and volume history, courtesy of Bloomberg
BABA price and volume history, courtesy of Bloomberg

BABA’s 6 day realized volatility is around 45 (does not include the first day pop), and the options market has priced 30 day implied volatility in BABA around 39 to start in today’s trading.

That seems like a reasonable level for several reasons.  First, while BABA is a $220 billion market cap company, its high growth and operating leverage could be a source of business volatility on both the upside as well as the downside.  FB is one of the few $200 billion market cap internet companies with similar growth expectations to BABA, and its 30 day implied volatility is around 33.  However, FB has much more price history after more than 2 years as a public company, in addition to a more transparent corporate structure and a better understood long-term business model.

Second, BIDU and JD, two large Chinese internet ADR’s, have generally experienced volatility in the 35-55 range over the past 3-6 months.  While both companies are much smaller than BABA (BIDU is $77 billion market cap, JD is $35 billion market cap), both are examples from a similar sector and possible investor cohort.  We would expect BABA volatility to be lower than both BIDU and JD over the long run, but since the stock still has less than 2 weeks of trading history, it is reasonable that BABA’s implied volatility is close to BIDU’s level of 38 (JD is at 51, and it is the smallest comapny of the three).

As for today’s options volumes, BABA implied volatility has gradually moved lower since the open. So far there were two trades that stand out.  First when the stock was $88.42, a trader sold the November 85/95 strangle at 7.30 to open, 3,000x, (sold 3k of the the 95 calls at 3.30 and sold the 3k of the Nov 85 puts for 4.00).  This was likely a yield enhancement strategy for a long holder.  If the stock is between 85 on the downside and 95 on the upside on November expiration then the investor will receive the $7.30 in premium, or about 8% of the underlying stock price in about 6 weeks.

The other trade that caught our eye was the purchase of a short dated collar, where an investor sold 3k of the Oct 90 calls at 2.60 to open and used the proceeds to buy 3k of the Oct 87.5 puts for 2.67, this structure cost 7 cents.  If the stock is between 87.50 and 90 on October expiration the trade has the gains or losses of the stock in that range.  If the stock is below 87.50 the trader has protection below that level (less the 7 cents in premium it cost to put on the hedge).  If the stock is 90 or above the long stock position is called away.  This is a classic risk management trade, possibly for someone who is restricted from selling the stock.

With vol elevated, we would expect for holders to continue to look for ways to add yield to existing holdings, while those looking to protect holdings will also look to finance the purchase of puts.

If we do get involved in BABA options over the next few weeks, it will likely be through a short volatility structure as we expect implied volatility to gradually decline given the size and nature of BABA’s IPO.