Increased regulatory scrutiny has weighed on Alibaba stock in recent months.
It is no surprise that implied volatility has gone through the roof with Alibaba (BABA). The current level of 43% is one of the highest readings in the last 12 months.
Traders thinking that volatility might drop while prices stabilize could look at an iron condor trade for Alibaba stock
When volatility is high, the iron condor can be placed further out of the money, giving the trade a higher chance at success.
Alibaba Stock: Iron Condor
As a reminder, an iron condor combines a bull put spread and a bear call spread.
The idea with the trade is to profit from time decay, with the expectation that the stock will not move too much in either direction.
First, we take the bull put spread. Using the October 15 expiry, we could sell the 145 put and buy the 140 put. The spread could’ve been sold Wednesday for around 70 cents per share.
The bear call spread could be placed by selling the 195 call and buying the 200 call. The spread could’ve been sold Wednesday for around 70 cents.
In total, the iron condor will generate around $1.40 in premium.
The profit zone ranges between 143.55 and 196.45. This can be calculated by taking the short strikes and adding or subtracting the premium received.
As both spreads are $5 wide, the maximum risk in the trade is 5 – 1.45 x 100 = $355.
Therefore, if we take the premium ($145) and divide by the maximum risk ($355), this iron condor trade has the potential to return 40.85%.
If price action stabilizes, then iron condors will work well. However, if Alibaba stock continues to bounce around, the trade will suffer losses.
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One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $145, so we could set a stop loss at 1.5 times the premium, or a loss of around $217.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
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View more information: https://www.investors.com/research/options/alibaba-stock-sets-up-for-iron-condor-trade-that-could-yield-41-percent/