Alibaba Group Holding Limited (NYSE:BABA) : The One-Week Pre-earnings Momentum Trade With Options
Date Published: 2018-08-12
DisclaimerThe results here are provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation.
PrefaceThere is a bullish momentum pattern in Alibaba Group Holding Limited (NYSE:BABA) stock 7 calendar days before earnings, and we can capture that phenomenon explicitly by looking at returns in the option market and looking at a simple technical indicator.
A Pattern in the ChartsFor the last year, this pattern has been particularly strong, which we will see explicitly at the end of this dossier, and roughly in the chart below. But, what we can see in the chart below that BABA has been above its 200-day moving average (200-DMA) for a long time (that black curve), and it is now below it.
It is a reasonable extra condition for application to only enter this back-test if the stock is trading above that black curve (200-DMA), and if not, to ignore at, put a pin in it for next quarter, and move on.
As of this writing, BABA stock is at $180 and the 200-DMA is $186.81.
According to our data provider, Wall Street Horizon, BABA has earnings due out on 2018-08-23, before the market opens, so 7-days before then would be 2018-08-16.
The Bullish Option Trade Before Earnings in Alibaba Group Holding LimitedWe will examine the outcome of getting long a two-week slightly out of the money call option (40 delta) in Alibaba Group Holding Limited 7-days before earnings (using calendar days) and selling the call before the earnings announcement.
Here's the set-up in great clarity; again, note that the trade closes before earnings, so this trade does not make a bet on the earnings result.
RISK MANAGEMENTWe can add another layer of risk management to the back-test by instituting and 40% stop loss and a 40% limit gain. Here is that setting:
In English, at the close of each trading day we check to see if the long option is either up or down 40% relative to the open price. If it was, the trade was closed.
RESULTSHere are the results over the last two-years in Alibaba Group Holding Limited:
The mechanics of the TradeMachine® Stock Option Backtester are that it uses end of day prices for every back-test entry and exit (every trigger).
We see a 505% return, testing this over the last 8 earnings dates in Alibaba Group Holding Limited. That's a total of just 56 days (7-days for each earnings date, over 8 earnings dates). This has been the results of following the trend of bullish sentiment into earnings while avoiding the actual earnings result.
We can also see that this strategy hasn't been a winner all the time, rather it has won 7 times and lost 1 time.
Setting ExpectationsWhile this strategy had an overall return of 196.2%, the trade details keep us in bounds with expectations:
➡ The average percent return per trade was 40.3%.
➡ The average percent return per winning trade was 52.3%.
➡ The percent return for the losing trade was -43.3%.
Is This Just Because Of a Bull Market?It's a fair question to ask if these returns are simply a reflection of a bull market rather than a successful strategy. It turns out that this phenomenon of pre-earnings optimism also worked very well during 2007-2008, when the S&P 500 collapsed into the "Great Recession."
The average return for this strategy, by stock, using the Nasdaq 100 and Dow 30 as the study group, saw a 45.3% return over those 2-years. And, of course, these are just 8 trades per stock, each lasting 7 days.
* Yes. We are empirical.
* Yes, you are better than the rest now that you know this.
* Yes, you are powerful for it.
Back-testing More Time Periods in Alibaba Group Holding Limited
Now we can look at just the last year as well:
We're now looking at 252% returns, on 4 winning trades and 0 losing trades.
➡ The average percent return over the last year per trade was 52.2%.
Back-test DiscoveryWe simply look across the S&P 500 100 and the "7-days Pre, Long Call" strategy scan.
WHAT HAPPENEDBullish momentum and sentiment ahead of earnings has been, empirically, a repeating pattern both in a bull and bear market for some companies. This is just one example of what has become a tradable phenomenon in Alibaba Group Holding Limited.
Tap Here, See for Yourself
You should read the Characteristics and Risks of Standardized Options.
Past performance is not an indication of future results.
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.