On and off the price chart, Alibaba Group Holding Ltd (NYSE:BABA) is building the case for investors. But if you’re going to position, rather than purchasing BABA stock, a modified butterfly looks like the right type of merchandise to buy. Let me explain.
Alibaba, or what many rightly call Asia’s Amazon.com, Inc. (NASDAQ:AMZN) recently reaffirmed its position as the continent’s 800 lb. gorilla after delivering a stellar Q4 confessional. Bottom line, BABA’s solid earnings beat, raised guidance and enviable growth prospects in key markets as InvestorPlace’s Luke Lango recently laid out are simply hard to ignore — or worse yet, bet against.
I’d wager Alibaba stock’s off-the-chart offerings were likely enough to force some of BABA’s resident bear population into hibernation. And on the BABA stock chart, while there’s still two sides to every story, I’d be equally wary of betting against Alibaba.
BABA Stock Daily Chart
Alibaba shares are currently setting up in a lower high pattern following two failed breakout attempts above the prior all-time highs set in the fall of 2017. With a lower-low confirming the weaker series of highs, it’s easy enough to see an emerging downtrend. Coupled with an overbought stochastics, the technical picture hints at a good spot for bears to short BABA stock. But the big picture is actually not that black and white.
Alternatively, investors wouldn’t be wrong to appreciate BABA as building a bullish and corrective base-on-base pattern over the last several months. The same bearish price action described above could just as easily be viewed as a bullish and constructive “W” or high-level double-bottom pattern.
The large base now appears to be putting the finishing touches on a handle consolidation that has held slightly above the key 2017 high. And given the bullish earnings reaction which preceded the tight price congestion, this strategist is inclined to see a breakout and new highs as the path of least resistance.
BABA Stock Modified Bullish Butterfly
One spread combination favored for this type situation where I’d like to see pattern follow-through and stay away from additional downside exposure in the event the bear case plays out is a bullish modified butterfly combination.
By positioning with a modestly out-of-the-money butterfly and designing the spread so the embedded bull call vertical is wider than the higher positioned bear spread, this bullish trader enjoys the benefits of limited and reduced risk. Another important feature is that the combination eliminates the potential headache of BABA stock moving too strongly and resulting in a loss of the debit above the butterfly’s highest wing.
Reviewing Alibaba’s options market, the long July $200/$220/$230 call butterfly is attractive. With shares at $198 the spread is priced for $4.10%, or just over 2% of the risk associated with buying BABA stock.
Despite the fairly insignificant downside risk for the next two months, this BABA stock butterfly has a maximum profit capture of $15.90 if shares are at $220 on expiration. While nice to think about, the combination of time and price would require a genie to work its magic for that type of perfection to play out.
More realistically, profits for this spread do build dollar-for-dollar with shares above $204.10 and should enjoy a nice return on investment as a breakout above $200 takes hold. And if conditions become really over-the-top in this often overly-optimistic bull market, BABA still enjoys a healthy profit of $5.90 above $210.
Investment accounts under Christopher Tyler’s management do not currently own positions in any securities mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. . For additional market insights and related musings, follow Chris on Twitter @Options_CAT and StockTwits.
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