Event: Alibaba (BABA) reports Q3 results tomorrow before the open. The options market is implying about a 5.5% one day post earnings move, which is rich to the 4 qtr average one day post earnings move of 4.25%, and a tad above its 5.2% average since going public in Sept 2014.
With the stock at $101, the Nov 4th weekly 101 straddle (the call premium + the put premium) is offered at $5.70, if you bought that and thus the implied move you would need a move above $106.70, or below $95.30 to just break-even.
Price Action / Technichals: BABA has had a monster year, up 24%, and up 108% from its 52 week lows made in February.
BABA has sold off about 10% from its 52 week highs made in late September, and just today bounced off of near term support near $99. The next meaningful support is at the mid August post earnings gap level of $91:
Implied Volatility Snapshot: short dated options prices are well above the levels prior to their Q2 report in August, with 30 day at the money implied volatility (the price of options, in blue) at 37.5%, with the gap to realized volatility (how much the stock is moving, white below) at 22%, and dropping, the widest its been in a while, highlighting that options are very expensive into the print:
My View into the print: In each of the last two Q3 reports since going public in Sept 2014, the company was able to offer guidance for Q4 that was buoyed by their upcoming Singles Day (Nov 11). That sent shares higher by 4% in each instance. I suspect this time will be the same. But given the stock’s run, and their push (investment) into so many different businesses (finance, epay, movies, cloud hosting etc etc) we might see the sort of uptick in spending (decline in margins) that spooked Amazon (AMZN) investors last week.
Therefore those looking to play for a bounce back to the prior highs should consider defined risk strategies that look to mitigate the post earnings vol crush and define risk in case of an Amazon type reaction.
So What’s the Trade?
Bullish/ Stock Alternative:
Buy the BABA ($100.70) Dec 100/110/120 call butterfly for 2.40
- Buy 1 Dec 100 call for 5.40
- Sell 2 Dec 110 calls at 1.70 (2.40 total)
- Buy 1 Dec 120 call for .40
Break-even on Dec Expiration:
Profits: up to 7.60 between 102.40 and 117.60 with max gain of 7.60 at 110
Losses: up to 2.40 between 100 & 102.40 and between 117.60 and 120, with max loss of 2.40 below 100 and above 120
Rationale – this trade defines risk to just 2.40 up to nearly the $6 implied earnings move. It targets the 2016 highs where there’s likely to be resistance on a move higher into year end. It breaks even at 102.40, just above where the stock currently trades. It’s main risk is a move lower obviously, but with a Dec expiration a small move lower won’t destroy the premium and it can either be held for a bounce or closed for a loss that won’t be its entirety. On a move higher patience will be needed but as long as the stock is above the break-even of 102.40 collapsing vol will help gains.
OR
For those that are already long the stock, and particularly for those that own it from lower and would like to protect gains without the tax implications of selling the shares, protection against a sharp move lower for little cost makes sense
Hedge:
vs 100 existing shares of BABA ($100.70) sell 1 Jan 120 call and buy 1 of the Jan 90/75 put spread for .90
- Sell 1 Jan 120 call at .80
- Buy 1 Jan 90 put for 2.15
- Sell 1 Jan 75 put at .45
Rationale – This collar costs less than 1% of the underlying stock price and protects against a breakdown in shares out to January expiration. On the upside the call sold is at the all time high so you must be willing to be called away at that level, but that sort of move even if possible would not happen on a gap so there’s plenty of time to adjust if the stock threatens that level. On the downside the 15 dollars of protection doesn’t kick in until the $90 level, but that level is significant as it was the last earnings gap level and a therefore a potential breakdown level. On this earnings event itself the overlay will have mark to market gains and losses directionally, but only on about 25 deltas initially. Those deltas will approach zero into January if the stock is between 90 and 120, both significant levels:
[caption id="attachment_67697" align="aligncenter" width="736"]
BABA since IPO from Bloomberg[/caption]