Monday is a big day for those who have been longing to trade Alibaba’s shares. The Chinese e-commerce giant (NASDAQ:BABA), up 1.66 percent or $1.48 to $90.4 posted a record $25 billion IPO about a week ago. These shares are expected to become available on September 29th.
“Because purchasing downside protection will be overpriced, I absolutely would not want to come in and buy puts”
Jim Strugger
Alibaba’s options contracts pegged to its underlying stock can be used to speculate on shares behavior of publicly traded companies. ‘Put’ options gives holders the right to sell at a particular time while ‘call’ options gives the holder the right to buy a given amount of shares at a specified price. The contracts can also be used to guard against share losses and speculate its prospects.
MKM Partners Derivatives Strategist Jim Strugger, said investors can expect two things outright with Alibaba’s stock.
- The option will be active
- Implied volatility, a key component pricing options will be high.
If we can pick examples to follow from previous high profile internet Initial Public Offerings, “it is most likely going to cost you a lot more to buy protection against a decline than to bet on further gains”, said Todd Salamone, director of research at Schaeffer’s Investment.
He is referring to what option traders refer to as “Bearish Skew” i.e. the price of put options will likely cost more than the price of call options. That remains even if both options have similar expiration and strike prices from their current prices.
Alibaba shares were up 0.9 percent at $89.73 in Friday afternoon trade. They are still 32 percent above the IPO price of $68 but fallen 4.4 percent since closure at $93.89 on their first day of trading on September 19th.
Strugger said “Because purchasing downside protection will be overpriced, I absolutely would not want to come in and buy puts”. He further added, some investors who already own Alibaba shares may desire to extract a profitable premium in options by selling calls, with strike prices above current rate following increased demand. A strategy commonly referred to as “selling covered calls,” confines the potential gain and while it does not offer comprehensive downside protection like purchasing a put would, the money collected upfront helps to minimize the downside risk.