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Transcript
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DRAlibaba did have a listing in Hong Kong ages ago and shareholders were wiped out. Fraud rhymes and repeats I guess.
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TTWhen going on Real Vision as a contributor, one has a responsibility to know there are people watching who have less experience, different risk tolerance, and time frames. I always try and give the easiest to understand trade with plenty of time to work. I also stressed on the video to take some profits when you get them. I took 25% of my trade off today with Ali Baba down 6% today. Thanks for watching!
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MTThe following is not a commentary on Mr Thornton's bearish viewpoint on BABA, he will likely have better insights into BABA than I. What I would like to comment on is the structure of his option position. Mr Thornton's specific long put spread has a suboptimal probability of profit (PoP) of 33%. One benefit of using options there is mathematical framework available we can use in advance of placing a trade to know the math based percentage probability of profit. Once folks have a detailed mathematical understanding of how Options are priced, how the option market actually works, and that with an option position there are three factors at play 1./ Direction, 2./ Time decay, 3./ Volatility of prices then for Mr Thornton to suggest 'he sees potential for 5 times the PREMIUM paid is there is no mathematical basis to make such a claim. Of course the trade might work, but over time only placing Options trades with optimal mathematics, with optimal Probability of Profit will lead to greater P&L consistency. Mr Thorntons Trade: 130/160 long put spread in Feb cycle Probability of making at least $0.01 Profit at expiry = 33%. A big downside to this specific trade it has -'ve Theta of $1.889 loss per day i.e. time decay will work against it AND it has a suboptimal PoP of only 33%. A better way to place a long PUT spread but with positive Theta (i.e. time decay working in your favour) and a higher profit potential is buy an ITM Put and sell an OTM PUT. This ensures positive time decay AND a break-even above the stock price at time of position entry. Finding the correct ITM option with intrinsic value greater than the debit paid will give a positive Theta trade. Now probability of profit to make at least $0.01 is 54% an improvement of 21%. Downside of this approach? The debit paid will be over twice as much as Tommys but what we get in return is a greater chance of success i.e. a greater probability of profit and positive Theta time decay working in our favour. Looking at the prices in the option market for BABA at this moment in time I don't like either of the above approaches. For those that have a directional bearish in BABA a better overall approach with a much improved PoP: as the FEB ( I don’t like going that far out myself) cycle in BABA has an implied volatility of 33.9% (at time of writing) the premiums are therefore 'relatively' rich and therefore present an opportunity to SELL a Call ratio spread e.g. sell 2 x 185 Call and buy 1 x 190 Call has a probability of profit of 70% (over twice as better as Tommys) at time of writing. Unlike the above two trades where we have to pay a debit the above call ratio spread will be a SELL to open trade for a credit of $12.87 If we limit our expectation of profit to 50% of credit received and get out by BUYING back to close when the market price for the position falls to $9.68 the probability of profit jumps to 83% which I think compares rather well with Mr Thorntons 33% PoP. One additional extremely important benefit of selling options for credits (aka short premium) as opposed to debit trades, with the vast majority of short premium option strategies if/when the position starts to move against you, it will usually be possible to 'adjust' move strikes up, down, roll out in time and receive additional $ credits for doing so. The P&L viability of regularly adjusting such short premium (credit) positions is a relatively new phenomenon for retail option traders in last 5-7 years or so made possible by the dramatic fall in trading commissions if using the correct brokers e.g. $1 per contract to enter, $zero to close AND the introduction HFT Market Makers (e.g. Citadel) competing for order flow from Retail brokerages enhancing liquidity, closer spreads.
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MZHere's a new title for you: Is Alibaba is a complete fraud? https://deep-throat-ipo.blogspot.com/2019/08/the-baba-investor-calltrade-warwhat.html
JAKE MERL: Welcome to Trade Ideas. I'm your host, Jake Merl, sitting down with Tom Thornton, founder of Hedge Fund Telemetry. Tom, great to have you back on the show.
TOM THORNTON: Thanks for having me.
JAKE MERL: Today, we're here to talk about Alibaba. It's up about 15% over the past few months, just since May, and up roughly 30% or so it's year to date. We'd love to get your thoughts of what you make of the stock right here, and what you expect in the months to come.
TOM THORNTON: I like Alibaba as a short. There's a couple reasons why I like it as a short. One thing I'm not going to talk about today are the fundamentals or the myriad of accounting, which I'll leave that to the experts. It's a very difficult balance sheet to try to uncover. What I'm looking at right now are the technical factors and liquidity, the stock has made a lower high and it has a weekly demarked sequential countdown 13. The last time that happened was at the high in June of '18. I see this as an exhaustion signal.
There's also another issue that I think is really, really important. It's the short interest. Back at the end of May, there were 116 million shares short. Now, there's 19 million shares short. That's 11 days to cover back then and now, one day to cover presently.
JAKE MERL: With the low short interest and the upside demarked exhaustion signals, basically you're saying there's like dry powder now where the stock is vulnerable. What would you say as a specific catalyst to actually get the stock falling? What are you looking at there?
TOM THORNTON: Well, we're coming into a weaker seasonal period for Alibaba. The second half is typically a weaker time. There is a very important catalyst that is a potential. I don't know if it's going to happen but right now, SoftBank owns 26% Alibaba and they've owned it for years pre-IPO.
In June, they sold $11 billion worth of stock, about 3% of the total float. It was a very well-known telegraphed sale that they announced in 2016. I think a lot of that short interest was already built up into that, and a lot of the shorts covered into that secondary.
If they suddenly have to start selling a little bit more Alibaba because of the disaster that they're having with WeWork or let's say, Uber, which is underwater from their pre-market or pre-IPO buy-in, this could be a real problem here. I don't think the market can absorb a 3% to 5% of liquidation if they have to announce it. I think the market will take it very, very bad.
JAKE MERL: How do you suggest traders play the current situation? Would you suggest going out and shorting the actual stock, or is there an options trade you recommend?
TOM THORNTON: Well, if you're long the stock, sell it. That's first. I think shorting the stock is fine. It's very liquid. Again, there's not a real risk of short squeeze with one day to cover. I'd use like a $200, $205 stop but there's also ways of playing it with options. I look at the $160, $130 February expiration. You're paying about six bucks, five to six bucks, and you get a five to six times your money if it goes to the lower strike at expiration in February.
JAKE MERL: When trading this option, do you have a risk management tactic in mind? Like would you be okay losing your premium, the $5 or $6, or would you get out of the trade at a certain point?
TOM THORNTON: Well, look, when you're buying a long position with a put or a call, you definitely run the risk of losing everything you have. What I typically do is if I start making money in an option, I'll take some off. If this goes wildly against me, I'll take the lower strike off and then hold on to what's remaining of the higher strike.
JAKE MERL: You have the liquidity factors on your side, the seasonal factors, and also the technical factors. This all looks great, but what would you say is the biggest risk to your trade? Where could things go wrong?
TOM THORNTON: Well, there's a couple things that the market could interpret as being very, very positive, a China trade deal. The market would price that in and say, "Well, this is great." There's also the risk of them doing a listing in Hong Kong. They've been talking about doing it for a long time. It just hasn't materialized yet.
JAKE MERL: Well, Tom, thanks so much for coming on the show. We'll see how it plays out in the months to come.
TOM THORNTON: Thanks. We'll see.
JAKE MERL: Tom is bearish on Alibaba. Specifically, he likes buying the February $160, $130 put spread for approximately $5. He sees a profit as much as five times the premium paid.
That was Tom Thornton, founder of Hedge Fund Telemetry. For Real Vision, I'm Jake Merl.