- Alibaba (BABA) stock is dirt-cheap — at its lowest levels in 6 years — after an earnings beat.
- Its chart shows that a major support area has held.
- I would suggest selling calls to hedge BABA stock.
Source: testing / Shutterstock.com
Chinese e-commerce giant Alibaba Group (NYSE:BABA) reported earnings this morning that beat on both the top and bottom line. Earnings per share came in at 16 cents versus expectations for just 14 cents. Revenues of $32.1 million also exceeded consensus for $30.8 million. Annual active users reached 1.3 billion. Additionally, Chinese users surpassed the 1 billion threshold. This may finally be the good news that can get BABA stock going.
Steve Booyens of InvestorPlace recently opined about 5 oversold Chinese stocks to buy before they rebound. He mentioned BABA as one of the five and highlighted the dominance Alibaba has in the e-commerce market along with historically cheap valuations.
Valuations are looking decidedly more attractive. Price-to-sales is now under 2 and nearing its lowest levels in the past decade. Other traditional valuation metrics, such as price-to-earnings (P/E) and price-to-free-cash-flow, are also at trough multiples.
For example, the forward P/E for BABA stock is 9.86. At some point, valuations do matter, especially for a company that is still growing at the pace of Alibaba. Investors with a longer term horizon will likely be rewarded for buying BABA now.
Certainly, the stock analysts agree that BABA stock is a buy. TipRanks shows the consensus of 18 analysts covering Alibaba is a “strong buy” rating. The average price target is $171.07 — an 83% increase from today’s price of BABA stock. Even the lowest price target is still a rather respectable $132.
Alibaba Group Holding Limited
Click to EnlargeSource: thinkorswim® platform from TD Ameritrade
BABA stock held critical long-term support at the $80 area after reaching oversold levels. Shares traded back to prices not seen since July 2016. Alibaba has fallen over 70% from the recent all-time highs in October 2020 near $320. The selling has certainly gotten extreme.
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Alibaba stock has traded below the 20-day moving average for all of 2022. This is a rare occurrence for stocks and for BABA in particular. A move back to challenge that 20-day moving average near $100 is a distinct possibility. Certainly, BABA is due for a bounce, especially given that it held major support and just beat earnings handily.
Implied volatility remains elevated on BABA stock options due to the recent carnage in the shares. This means option prices are comparatively expensive, which favors selling strategies when constructing trades. So, to position for a pop in Alibaba, a covered call strategy makes intuitive sense.
Covered calls, or buy-writes, involve buying stock and then selling protective calls against that stock purchase. Since each call controls 100 shares of stock, you would sell 1 call for every 100 shares of stock bought. Effectively, you give up some of the upside in the stock to protect yourself from some of the downside. All in all, it is a lower risk way to take a more guarded bullish stance.
How to Trade BABA Stock Now
Buy BABA stock around $90 and sell BABA Jan $100 calls around $13 for a $77 net debit.
Selling the calls reduces the initial cost of the trade by the premium received of $13 per call sold. So, 14% downside protection by selling the call, while still allowing for a potential gain of 30% if BABA stock closes above $100 at January expiration.
In my opinion, it always makes sense to take a more measured approach in any market environment. It definitely makes even more sense now, given the current crazy market conditions. Investors looking to dip their toes back in the water may want to consider a covered call strategy on bargain basement BABA stock.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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