Alibaba and Forty Thieves

Well, hoestly, it is not the story of the Forty Thieves. But rather of Superior Profit invetors. Alibaba is still there – and is the main character you might say. And there is certainly a lucrative profit potential.

Here is our investment in Alibaba – taken on 31st Dec 2015 as the last year was passing by.
Alibaba (Thomson Reuters symbol BABA.K) Business Summary:

Alibaba Group Holding Limited is a holding company. The Company is principally engaged in online and mobile commerce through products, services and technology. The Company provides retail and wholesale marketplaces available through both personal computer and mobile interfaces in the PRC and internationally. Retail marketplaces and services operated by the Company include the China online shopping destination (Taobao Marketplace); the China brands and retail platform (Tmall); the China group buying site that offers products by aggregating demand from consumers through limited time discounted sales (Juhuasuan), and the global consumer marketplace targeting consumers around the world (AliExpress). Wholesale marketplaces operated by the Company include the online China wholesale marketplace (1688.com) and the online business-to-business marketplace that focuses on global trade among businesses from around the world (Alibaba.com).

Superior Profit Analysis:

Note: The stock and option analysis diagrams below were prepared after market close of 31st Dec 2015 whereas the position was taken during the trading hours of 31st Dec.

I used CUE Background template to look at Alibaba’s Weekly chart first. That is, starting my analysis by taking a step back to see the stock’s entire price movement since inception.

After a well publicized IPO in September 2014 (A), Alibaba stock went to 120 in Nov (B) same year. And then went for a sharp downfall. By September 2015, within one year of IPO, Alibaba had reached a Low of 57.2 (C). That was a drop of more than 52% from Alibaba’s peak price. This shows that even a company with strong (apparent) business model does not guarantee that it will be a good Buy and Hold candidate.

Then in late Sep/early Oct of 2015, Alibaba displayed a Bullish Headwind in Weekly chart (C ) and since then it has been going up. Taking a Long position using this Headwind signal would be extremely profitable at that time.

At the right side of the chart (D), BABA has entered a sideways Triangle formation in Weekly. For more than two months it has failed to make new High.

Now that BABA is clearly not going up, I decided to zoom into Daily chart using Hop On template to see what we I could infer from there.

Hop On chart further reinforced the sideways movement of BABA. It moved up-down within a narrowing Triangular formation bouncing from at E, F, G, H, I and J; every time making a Lower High and then a Higher Low.

Looking at Weekly Backdrop and Daily Hop On charts as explained above I concluded that BABA was moving sideways. However, at the right edge, the Triangle has narrowed significantly and a breakout is highly likely in either direction. Therefore, I decided not to go for an investment based on continued sideways movement (which could be taken with Iron Condor or other Option set ups or by Shorting the stock at peaks and Buying the troughs).

Instead, I wanted to look deeper (or broader !) in the Index to which Alibaba belonged. In this case, it was NYSE Acra China Index. For this index, I was interested only in the price bar movements. This is seen below through Hop On template.

I noticed from this chart that, interestingly but not surprisingly, NYSE Acra China Index made a top at same time that Alibaba made a top in Nov 2015 (M). And since then moving sideways with a very slightly Bearish bias.

Now, armed with the sideways movement in BABA, a narrowing Triangle in BABA that might lead to a breakout in either direction and the fact that the broader China Index was also struggling to go up, I decided to try to find out a limited risk position with Bearish bias. A Bear Put Vertical would allow such a trade setup. I wanted to buy an In The Money Put leg and sell and Out of The Money Put leg provided the leg I was selling was more expensive than the one I was buying (this “expensiveness” being visible in Implied Volatility). I found from the Option Chain (not shown here) that BABA January (15th) 82/78 Put Vertical gave me such a trade set up. The Put 82 (In The Money) leg had Implied Volatility of 29.6% whereas the Put 80 (Out of The Money) leg had Implied Volatility of 32.6%. These two legs are marked as levels K and L in the BABA Hop On chart shown earlier.

Next step for me was to find out the potential Reward Risk Ratio and theoretical probability of win. I found that out from the Option Analysis diagram below.

As you may see, the Vertical had about 30% theoretical chance of closing below 78 at expiry (N) and at that point the position would have about 93% profit on initial debit amount.

Also, the Max Profit Potential was 269 (per contract) and max Loss Potential was 131 per (per contract) – giving a Max Reward Risk Ratio of about 2.

Now, initially, the 30% probability of winning might look less of a probability to risk investor’s money. However, that is based on simple statistical volatility and does not take into account the directional bias that I had based on the CUE charts analysis that I did above. So, when I considered the directional bias I had, I was fine with this level of theoretical probability and Reward Risk Ratio.

Why did I go for Put Vertical instead of going for simple Put? Several reasons for that, One is that I wanted to reduce the purchase price of the Put. I was anyway going to close my position and book profit on the Put by the time BABA went to 78. So I decided to Short that leg – it would be still Out of The Money when I close my position. And my Long leg (82 Put) would be very much In The Money. Giving me a benefit of good reward while reducing my cost base.

There is another reason for which I choose the Vertical – that will be clear in the Next Step explained below.

Based on the above analysis, I have taken a Bearish position in BABA with the Jan 82/78 Put Vertical on 31st Dec 2015.

What next?

BABA already went down on entry day and the position is in some profit.

I have placed a Good Till Cancelled profit booking order on the vertical. So it will close atomically when the profit target is reached. I do not need to do anything else.

Now, what is to be done if BABA goes up instead of going down? That is indeed possible – BABA is inside a Triangle shape in Daily chart at present …. This is where the Vertical may come of use (instead of using simple Put). If BABA were to indeed go up, I would wait for it to start to go down again (assuming some time it starts to go down after going up). At that (peak) point, the Short leg will be losing most if not all of its value. And I would prefer to buy it back. Leaving me with only the Long Put leg. And any subsequent down move would result in considerable profit on the Long Put (compared to what would have been achieved with the Put Vertical). This is another reason I choose the Vertical instead of simple Put.

Note that if BABA was in clear downtrend giving me a Go With Flow Short signal, I might have chosen simple Put instead of choosing Vertical. This way, using Options gives us many creative ways of structuring our investment – using the structure that matches our view on the stock’s next probable move most closely.

We – as is customary in Superior Profit Way – will let this investment play out now. Planning the trade and trading the plan – as we always say !

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