As this transaction demonstrates, the Covered Calls Advisor intends to continue the pattern of prior months by establishing ongoing monthly Covered Calls positions in Alibaba. The quarterly earnings report was released before market open yesterday, and the stock has declined swiftly (by 8%) during the two market trading days since then. I believe this abrupt selling was caused by the decline in operating margins compared with prior quarters, a result that is understandable given the numerous growth initiatives (offline retail in China, international development, equity stake in Ant Financial, etc., etc.) that are being wisely pursued. Moreover, Alibaba's forecast is that revenue growth of about 55% will continue next quarter, in which case the trailing twelve months P/E ratio based on today's price would likely be about 37, high for most companies, but a good value given their ongoing growth potential. I consider the price action of the past two days to be unwarranted and hopefully the current oversold condition will reverse itself in very short order.
As detailed below, a potential return-on-investment result is +2.9% absolute return in 43 days (equivalent to a +24.4% annualized return-on-investment).
Today's transactions and potential result are detailed below:
1. Alibaba Group Holding Ltd. (BABA) -- New Covered Calls Position
02/02/2018 Bought 300 shares of Alibaba stock @ $187.30 per share
02/02/2018 Sold 3 Alibaba March 16th, 2018 $180.00 Call options @ $12.35 per share
Note: this was a simultaneous Buy/Write transaction
A possible overall performance result (including commissions) would be as follows:
Covered Calls Cost Basis: $52,554.60
= ($187.30 - $12.35)* 300 shares + $6.96 commission
Net Profit Components:
(a) Options Income: +$3,705.00
= ($12.35* 300 shares)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If BABA stock is above $180.00 strike price at March 16th expiration): -$2,194.95
= ($180.00 -$187.30)* 300 shares - $4.95 commission
Total Net Profit: +$1,510.05
= (+$3,705.00 options income +$0.00 dividend income -$2,194.95 capital appreciation)
Absolute Return: +2.9%
= +$1,510.05/$52,554.60
Equivalent Annualized Return: +24.4%
= (+$1,510.05/$52,554.60)*(365/43 days)
The downside 'breakeven price' at expiration is at $174.95 ($187.30 - $12.35), which is 6.6% below the current market price of $187.30.
A recent quantitative study titled "Which Index Options Should You Sell" () provides statistically significant insights to determine which options strike price and expiration date combination should be selected to sell. Figure 2 in this paper shows that the front month (i.e. next month) S&P 500 options in the range of -0.5 to -0.6 standard deviations on average provide a significantly better return than a basic buy-and-hold strategy. For this Alibaba position, the $180.00 Mar2018 monthly option was selected since its breakeven price is -0.6 standard deviations from the current price of $187.30.
Using the Black-Scholes Options Pricing Model, the probability of making a profit (if held until the March 16th, 2018 options expiration) for this Alibaba Covered Calls position is 67.2%, so the expected value annualized ROI of this investment (if held until expiration) is +16.4% (+24.4% * 67.2%), a nice result for this moderately in-the-money Covered Calls position.
The 'crossover price' at expiration is $192.85 = $187.30 + [$12.35 - ($187.30 - $180.00)].
This is the price at expiration above which it would have been more profitable to simply buy-and-hold Alibaba stock until the March 16th, 2018 options expiration date rather than establishing this Covered Calls position.
