As I mentioned in my update yesterday, I was under-invested and felt the need to add some more risk and upside potential to my account. My small and mid-cap allocation in ETFs takes up roughly 27% and 24% of my account respectfully. I have no large-cap or international ETFs in my account, but I have some large individual stocks to balance me a little. Since I don’t want to be overweight in any size sector, I went searching for a good trade on another large stock. I didn’t even both looking at the ETF, SPY, since its premiums don’t offer the punch I was looking for. I landed on BABA again and sold a new far out-of-the-money naked put.
While BABA was trading at $98.28, I sold one BABA December $87.50 naked put for $2.06 and received $204.91 after paying $1.09 in commission. The bid/ask was $2.05/2.10. The bid size was only eight while the ask size was a few hundred. That difference showed me the bid had a decent chance of dropping soon, so I didn’t try to target a better price, I entered a limit order for $2.05 and it hit immediately at $2.06 (thanks IB for the extra dollar). I usually avoid market orders because I’ve seen the bids drop a nickel or more when I enter my order and I end up getting a lower price than I could have with a limit order. Interactive Brokers doesn’t charge extra for a limit order versus a market order, so I didn’t have anything to lose. As happens with IB sometimes, I got a better trade than expected.
As the market sold off some in the afternoon (post-FOMC announcement), BABA rose some from the morning low of $96.83 and I saw the bid/ask for my option contract hit $1.80/1.90 before pushing higher into the close to finish the afternoon at $1.90/2.00. BABA’s drop from yesterday’s intraday high to this morning’s intraday low equaled a 3.8% move. I sold this put so far out-of-the-money because BABA is extremely volatile. It has only been nine days since BABA last hit $87.50 intraday, but now the 10 and 20-day moving averages are above my strike and ascending. I could see a 50% retracement of the past two weeks’ ascent, but don’t expect BABA to break down completely. I almost waited for a better entry point and then decided I should act now so I wouldn’t miss the opportunity to make a decent return this far out-of-the-money.
The $85 strike puts offered another 2% cushion, but took away more than 4% in annualized gains. Since I’m under-invested, I opted to sell the higher strike. The $90 strike offered more than a 22% annualized return, but I wanted the bigger room for error if I’m wrong about where BABA will find support. 16.63% is a good return and I don’t need to take bigger risks than that for an extra $75 in premiums.
BABA Naked Put Risk/Reward Breakdown
- Potential profit: $204.91
- Potential return: 2.40%, 16.63% annualized
- Breakeven price: $85.45
- Downside protection: 13.05%
- Recent high: $100.65, hit yesterday
- Cushion from the recent high: 15.10%
- Expected support: Today’s low of $96.83 might be tested again this week. I’m not positive it’ll hold support and am looking at the 10-day moving average, currently at $93.36, to be the first real test. It happens to coincide with the 61.8% Fibonacci line too. The 20-day moving average, at $90.15 today, has a better chance of offering support. It just moved above the 38.2% Fibonacci line and could hit the 50% retracement level ($91.73) by the time BABA drops that much.
- Position close goal/limit: I don’t think BABA will hit new all-time lows, but could see a retest of the mid-October low of $82.88. If BABA drops below $82.88, I’ll have to take a serious look at what is driving the fall. $80.52 would be a 20% correction and I don’t think we’ll see this cash flow machine correct this early after its IPO.