Trade Details & Summary

BABA Put Debit Spread (LIVE Opening Trade)

With BABA trading down over 6% on the day we jumped in with this new bearish put debit spread betting on continued weakness.


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In this video, I want to talk through the thought process that I have in finding a new bearish trade. In fact, we’re going to go fishing for one that I already have in mind, but I want to backtrack here and show you how I found it.

Now as we often do, we’re just using our watch list software that we built in-house right here at Option Alpha to go ahead and sort and filter it by all the different things that we can do. We can look for earnings trades or high implied volatility only, ETFs only, etcetera, and then filter down A to Z ticker, percentage change, implied volatility, stock price, whatever.

And what I often do most of the time is just take a look and see what stocks are either moving up a lot, so I’ll say highest percentage change on the day or lowest percentage change on the day, whatever it is. And in this case, we’re just going to look at stocks that are moving lower.

We want to get into a position that has something moving lower. We want to get bearish on something to give ourselves a little bit more balance against some of the other bullish positions that we already have. Now, taking a look at BABA right now, BABA is the number one stock on our watch list here that’s moving down the biggest today.

It’s down a little bit about 6% as of the last time that this is updated, just a couple of minutes ago. And yesterday, implied volatility was at the 11th rank, so low implied volatility although it's probably a little bit higher right now given the fact that the stock is down almost 6.5%.

But when we open up the actual chain here, you can see that the best strategies we want to use for this particular stock if we’re going to trade it are calendars, ratios, or debit spreads. In this case, I’ll tell you why we’re going to be using the debit spread after we take a look at the actual options chart itself.

If we go over here at BABA, you can see the stock is moving down today. It’s down a little bit more right now, just continues to fall at the lows, and we did get that jump up just quickly in implied volatility from around the 11th rank to around the 24th rank right now.

That’s one thing that we want to look at, is, of course, take a look at where implied volatility is because it’s going to tell us what type of strategy to use. In this case, it seems like it’s a breakout move lower. Now, I don't know what the reasoning is. I don’t care what the reasoning is. We’re going to play this thing directionally bearish because I think it’s going to end up being a good trade.

Now, when we go into the actual underlying options chain, there are a couple of different contract months that we can get into. We can get into the June contracts which are 23 days away, or we get into July. When it comes to buying options and the way that we do it…

If we’re going to get into a buying strategy and do it minuscule, I want to give ourselves as much time as possible to be right. In this case, I want to go out to the July contracts which have 51 days to go, and I want to do a debit put spread.

Now, a debit put spread traditionally is buying one option in the money, so in this case, the 77.5 puts, and selling one option just slightly out of the money, in this case, the 75 puts, so buying one and selling the other. Now when I do this, in this case, if I go ahead and buy one and sell the other, I come up with a debit price of about $1.28.

We’re going to move a bit down to $1.25. That’s where it was trading before we started doing this video. And that right now is exactly the midpoint of this spread. This spread is a $2.50 widespread, meaning that’s the difference between the actual strike prices, 77.5 and $75.

It’s a $2.50 wide and if the cost is a $1.25, that means that it's exactly in between or halfway, middle, whatever you want to call it, of the width of the strikes. Now, the reason that I like this trade a lot is that the maximum amount of money that you can make on this trade is $125, the maximum you could lose on this trade is $125.

If you think about it, we are indeed risking every dollar to make a dollar or a 1:1 risk-reward ratio. But what's cool about this is when you look at our breakeven points right here based on where the stock is now. Our breakeven point on this trade if we were to enter it right here is 76.25.

The stock is trading for 75.58, 75.59 and moving around here. What this means is that we are giving ourselves an opportunity to make a trade that has a 1:1 payoff ratio with a better than 50-50 chance of success because the stock can rally about $.75 and we could still make money on this trade.

We have a little bit of embedded edge here just because option pricing hasn't caught up with the fact that the stock is moving much, much lower and very, very fast. There’s a lot of liquidity and volume, but pricing just still hasn't caught up with how quickly it’s moving lower here today.

This is a cool debit spread trade in entering. This is why I want to do it on the live video here because it gives us an opportunity to get into this thing with pretty good pricing and premium. Now, I un-toggled the fixed price here, and I’ve got the prices now trading at about $1.30s, so you can see it’s quickly moving up towards more of an expected or average price based on where the breakeven point should be.

But somewhere around 128 is probably where it could fill. Even if we got in at 128, we’d be sacrificing a little bit of that 1:1 risk to reward ratio by about $6, so not a big thing, and we still have a very favorable breakeven point. If the stock rallied up to 76.22, we could still make a little bit of money.

We’re going to try to fill it at 125. It seems like that’s where it’s trading a little bit here. And we’re going to get into a couple of contracts since this is pretty favorable to do.

We’re going to go ahead and submit that order and sell and try to get into this spread. Now we’re going to work at 125. The market is sometimes trading down to 125 and sometimes not; it’s trading around 128. You can see that here by the market price.

But we’re going to let this order work for just a little bit. It's too kind of pricing actually to pass up because of the little-embedded edge. And I do think if the stock is breaking out lower, let’s give us 50 days to see if the stock continues to move lower. That's the whole idea behind making this trade.

Right now, it’s trading right at 125. It might take a little bit to get filled here. We need to find somebody else in the market that wants to take the other side of this trade here against our position. We’ll pause this video and come back as soon as this trade gets filled.

Alright, you can see here inside of our platform that we got filled about 30 seconds before the market closed today which is a late day fill, so I’m not sure what to expect with that. But patience did hold out here, and we are in at the 125 debit, so we’re looking at a pretty good trade here in BABA and hopefully a nice setup for the next month and a half.

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