Alibaba broke back below the 50-day moving average on Friday and continues to show deterioration in relative strength. Therefore, traders looking for a bearish option trade could look at a bear call spread on BABA stock.
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call. The strategy can be profitable if the stock trades lower, sideways or even if it trades slightly higher. What's key here? Alibaba stock stays below the short call strike price at expiry.
A June 21-expiring bear call spread on BABA stock using the 80 to 85 strike prices could get sold for around $0.75 per set of contracts, based on recent action.
Alibaba Stock Today: Setting Up The Trade
Traders selling the spread would receive $75 in option premium, or the maximum possible gain. The maximum loss would be $425.
The spread will achieve the maximum profit if Alibaba stock closes below 80 on June 21. In this case, the entire spread would expire worthless, allowing the trader to keep the $75 option premium.
The maximum loss will occur if shares close above 85 on June 21, which would see the premium seller lose $425 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy. So, you always know the worst-case scenario in advance.
You could set a stop loss if Alibaba stock trades above 80, or if the spread value rises from $0.75 to $1.50.
As this is a bearish position, traders who think the stock could move higher from here should not enter this trade. The position starts with a delta of -11, meaning it is roughly equivalent to being short 11 shares of BABA.
Key Ratings
According to IBD Stock Checkup, Alibaba ranks No. 17 in its group overall. It sports a Composite Rating of 48, an EPS Rating of 74 and a Relative Strength Rating of 19.
Alibaba is due to report earnings on May 24, so this trade would have earnings risk if held to expiration.
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.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
