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Thursday, June 29, 2017

Established New Position in Alibaba Group Holding Ltd.

Today, the Covered Calls Advisor established a new position in Alibaba Group Holding Ltd. (ticker symbol BABA) by selling two July 21st, 2017 Put options at the $135.00 strike price. This position is a relatively conservative one since it was established when the price of Alibaba was $138.41 (2.5% downside protection to the strike price) and 23 calendar days remaining until the options expiration date.

As detailed below, the Alibaba Group Holding Ltd. investment will yield a +1.9% absolute return in 23 days (which is equivalent to a +29.7% annualized return-on-investment) if Alibaba stock closes above the $135.00 strike price on the July 21st options expiration date. 

The Covered Calls Advisor does not use margin, so the detailed information on this position and these results shown below reflect that this position was established using 100% cash securitization for the two Put options sold.

The implied volatility of the Put options was 29.9 when this position was established; so the $2.56 price per share received when the Puts were sold is a nice premium for these out-of-the-money (i.e. strike price below the current stock price) Put options .

Alibaba Group Holding Ltd (BABA) --New 100% Cash-Secured Put Options Position
The transaction was as follows:
06/29/2017  Sold 2 BABA 100% cash-secured $135.00 Put options with July 21, 2017 expirations @ $2.56
Note: the price of Alibaba was $138.41 today when this transaction was executed.

A potential performance result (including commissions) could be as follows:
100% Cash-Secured Cost Basis: $27,000.00
= $135.00*200 shares

Net Profit:
(a) Options Income: +$505.75
= ($2.56 * 200 shares) - $6.25 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If BABA closes above $135.00 strike price at July 21, 2017 expiration): +$0.00
= ($135.00 -$135.00)*200 shares

Total Net Profit: +$505.75
= (+$505.75 options income +$0.00 dividend income +$0.00 capital appreciation)

Absolute Return: +1.87%
= +$505.75/$27,000.00
Annualized Return: +29.7%
= (+$505.75/$27,000.00)*(365/23 days)

The downside 'breakeven price' at expiration is at $132.44 ($135.00 - $2.56), which is 4.3% below the current market price of $138.41.

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing Calculator, the probability of making a profit (if held until the July 21st, 2017 options expiration) for this Alibaba short Puts position is 65.0%. This compares with a probability of profit of 50.2% for a buy-and-hold of this Alibaba stock over the same time period. Using this probability of profit of 65.0% the expected value annualized return-on-investment (if held until expiration) is +19.3% (+29.7% maximum potential annualized return on investment * 65.0%), an attractive risk/reward profile for this somewhat conservative investment.  

The 'crossover price' at expiration is $140.97 ($138.41 + $2.56).  This is the price above which it would have been more profitable to simply buy-and-hold Alibaba stock until the July 21st options expiration date rather than selling these Put options.