Today, the Covered Call position in Alibaba Group Holdings Ltd.(BABA) was rolled down-and-out from today's May 14th, 2021 $225.00 strike price to the May 28th, 2021 $215.00 strike price at a net credit of $2.91 per share. The stock price has declined substantially from the original purchase price of $232.14 per share to $209.08 today when this rollout transaction was executed. The combination of China's government regulations and $2.8 billion anti-competitive fine as well as earnings per share below analysts' estimates are the primary reasons for this price decline.
Since yesterday's earnings report, seven companies have come out with decreased target prices for Alibaba. But as shown in the chart below, the average cut in their target prices was only 8.7%, so the adjusted average target price is now approximately $282.43, which is 35.1% above today's $209.08 price when this rollout transaction occurred. So, the Covered Calls Advisor decided to enter this rollout transaction which extends the expiration date two more weeks to provide some time to better evaluate whether Alibaba should continue as a core holding or if the position should be exited at a loss.
This commentary in the Q1 2021 Polen Global Growth Fund investor letter summarizes why Alibaba is in a dominant position with strong ongoing growth potential:
In the case of Alibaba, two significant news events impacted the company’s shares in the last few months of 2020. First, the Chinese government intervened to halt–for an undetermined period of time–Ant Group’s IPO. Alibaba owns 33% of Ant Group, and Ant Group’s “Alipay” application facilitates financing and payments around the Alibaba ecosystem. Second, rumors of Chinese regulatory oversight in the internet space were solidified at the end of 2020 when China’s State Administration for Market Regulation announced an investigation under the nation’s Anti-Monopoly Law. In combination, these events contributed to a sell-off in BABA shares that resulted in a roughly 30% decline from highs in late October 2020. We view Alibaba as arguably one of the most dominant businesses in the world. We believe the company is also playing an integral role in China’s ambitions to reorient its economy from one that is export-driven to one that is domestically consumption-driven. Alibaba’s marketplaces—TaoBao and Tmall—in combination with its logistics capabilities may well provide the most efficient way to purchase and receive goods in many of China’s lower-tier cities. Important to the investment case, Alibaba’s core commerce business continues to compound at high rates while enjoying low total addressable market penetration and multiple competitive advantages, not the least of which consist of two-sided network effects between merchants and consumers. At approximately 19x next twelve month’s earnings, we think Alibaba will provide a favorable investment outcome even if it must pay fines or modify some business practices. We continue to expect earnings growth in excess of 20% over the next three to five years. Even if earnings growth were to fall to 15%, we think it would still result in a favorable outcome at the price at which we added to the position.
As detailed below, two potential return-on-investment results are:
- -4.5% absolute return (equivalent to -62.8% annualized return for 26 days) if the stock price is unchanged from today's price of $209.08 on the May 28th, 2021 options expiration date; OR
- -1.8% absolute return (equivalent to -25.3% annualized return for 26 days) if the stock is assigned at the $215.00 strike price on the May 28th, 2021 options expiration date.
Alibaba Group Holdings Ltd. (BABA) -- Continuation of Covered Call Position
The buy/write transaction was as follows:
05/03/2021 Bought 100 shares of Alibaba stock @ $232.14 per share
05/03/2021 Sold 1 Alibaba May 14th, 2021 $225.00 Call option @ $10.24 per share
Note: The Implied Volatility of the Call option was 32.3 when this transaction was executed.
05/14/2021 Bought-to-Close 1 BABA May 14th, 2021 $225.00 Call Option @ $.01 per share and simultaneously Sold-to-Open 1 BABA $215.00 Call @ $2.92 per share.
Note: the stock price was $209.08 when this $2.91 net credit spread transaction was executed.
Two possible overall performance results (including commissions) would be as follows:
Covered Call Cost Basis: $22,191.34
= ($232.14 - $10.24) * 100 shares + $1.34 commission
Net Profit Components:
(a) Options Income: +$1,313.66
= ($10.24 - $.01 + $2.92) * 100 shares - $1.34 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If Alibaba stock price is unchanged at $209.08 at the May 28th, 2021 options expiration date): -$2,306.00
= ($209.08 -$232.14) * 100 shares; OR
(c) Capital Appreciation (If Alibaba stock price closes above the $215.00 strike price and is assigned at the May 28th, 2021 options expiration date): -$1,714.00
= ($215.00 -$232.14) * 100 shares
(a) Total Net Profit (If Alibaba stock price is unchanged at $209.08 at the May 28th, 2021 options expiration date): -$992.34
= (+$1,313.66 Call option income +$0.00 dividend income -$2,306.00 capital appreciation); OR
(b) Total Net Profit (If Alibaba stock price closes above the $215.00 strike price and is assigned at the May 28th, 2021 options expiration date): -$400.34
= (+$1,313.66 Call option income +$0.00 dividend income -$1,714.00 capital appreciation)
1. Absolute Return-on-Investment (If Alibaba stock price is unchanged at $209.08 at the May 28th, 2021 options expiration date): -4.5%
= -$992.34/$22,191.34
Equivalent Annualized Return-on-Investment: -62.8%
= (-$992.34/$22,191.34)* (365/26 days); OR
2. Absolute Return-on-Investment (If Alibaba stock price closes above the $215.00 strike price and is assigned at the May 28th, 2021 options expiration date): -1.8%
= -$400.34/$22,191.34
Equivalent Annualized Return-on-Investment: -25.3%
= (-$400.34/$22,191.34)*(365/44 days)
