BABA Stock Down on Government Antitrust Investigation
After Jack Ma of Alibaba (BABA) offered some critique of Chinese regulators, the government quickly suspended Ma’s other venture’s, Ant Group’s, highly anticipated IPO. The stock began moving lower on this news from it’s all-time highs in October of 319. Then on December 24th, it was announced that the Chinese government would open up an antitrust investigation into Alibaba which further put pressure on the stock with it dropping over 13% in one day. It seems to us, this is clearly intent to publicly humiliate Jack Ma by Chinese President Xi and the Chinese Communist Party. The government wants to remind him that even though he’s a wildly successful tech entrepreneur, he is not beyond the system and establishment, and want him to bow down to them and their oppressive regime.
While Alibaba may need to pay some fines and face some public humiliation, we can’t envision these event jeopardizing the very successful business or ultimately penalizing its shareholders once the dust settles. In the most recent quarter Alibaba posted 30% YoY revenue growth, 60% YoY cloud computing revenue growth. We were especially pleased on the cloud computing number since this is a rapidly expanding industry and can become a successful revenue driving cash cow SaS line of business for Alibaba, supplementing the company’s e-commerce revenue.
With China’s goal of expanding their tech presence, continuing driving their economy to global expansion, it becomes almost unthinkable that this was more than a way to put Alibaba and Ma on alert and to remind them to behave as the communist party expects. There has also been some additional pressure on Chinese equities with the Trump administration, but we think with the new Biden administration there will be less foreign policy surprises and expect to see Chinese equities to fair well, or at least not be further hindered, under the next US administration. All in all, we think this is a buying opportunity.
The Trade
Put Credit Spread
- Sell 1/29 $220 Put
- Buy 1/29 $215 Put
Max Gain/Credit: $240
Max Risk: $260
Selling a put is giving the buyer of the put the right to sell you 100 shares at the strike price. In this case $220. But since this is a spread, we’re hedging ourselves quite a bit. If we were to just sell the $220 put we would receive over $1000 dollars in credit, but if stock went to $100, we would have to buy 100 shares at $220 and we would be down $12,000 (minus the premium we received and keep either way).
However, since it’s a spread, we’re buying a cheaper $215 put, in addition to selling one. The put we buy is $240 dollars less than the put we sell, which is the credit we receive. Entering the spread, limits our credit received, but also greatly reduces our max loss to the width of the strikes ($220-$215) minus the credit we receive $240, which is how we calculate our max loss.
At this time BABA is just a nickel below 222. So as long as BABA stays at this level or goes higher by the expiration date, 1/29, the puts will expire worthless and either way we keep the $240 credit. In fact, if the stock goes down to $220, we still get the full max gain. The breakeven point is the short put spread $220 minus the credit received $2.40, which is $217.4. So we’re in the green as long as BABA stays above $217.4. Anything below $215, and we incur the max loss, $260.
Managing the Trade
We started with a modest width between the strikes, which yield a smaller gain but gives us the chance to roll the spread later if the stock does go below $220. For example, if BABA went to $200, and we were still bullish on the stock, in one transaction we could buy to close our $220 put, and sell to close our $215 put and open up a longer dated spread, with a wider width and collect even more premium - even as the stock moves against us. So in this example, we may be able to then roll the spread into a $205/$195 February or March spread. While this would increase our max risk, we would have a higher probability of success. However, this should only be done if your conviction hasn’t change on the stock.
This site references only our opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. Disclaimer: We are long BABA stock and net long in options