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This Consumer Trend Could Lead to Big Gains for Traders

This Consumer Trend Could Lead to Big Gains for Traders

While we tend to believe that the tech giants are firmly entrenched in their businesses, there could be room for competition even among the largest companies. For example, Amazon’s position as the world’s largest retailer may not be completely secure.

The Wall Street Journal recently ported that Alibaba (NYSE: BABA) could be gaining market share and even has room for growth. This is especially true for luxury goods.

According to the Journal,

“Despite being fussy about their image, luxury brands are teaming up with mass-market Chinese e-commerce giants Alibaba and JD.com .  Don’t expect them to act as friendly toward Amazon.

Luxury brands have mostly steered clear of Jeff Bezos’ internet sites despite their growing clout with consumers. LVMH ’s finance chief said in 2016 that “the existing business of Amazon doesn’t fit with luxury, full stop.”

Most brands don’t like the idea of being listed alongside less glamorous goods such as secondhand books and cleaning fluid.

Yet they are warming to Alibaba and JD.com. Valentino, Bottega Veneta and Burberry are all available on the Luxury Pavilion section of Alibaba’s Tmall website, and participation is growing.

In 2018, 26% of luxury fashion brands tracked by digital research outfit Gartner L2 had a store on Tmall, up from 21% a year earlier.

Less familiarity with the Chinese online market is one factor. Consumers in the country seem to prefer third-party sites that have lots of brands to choose from—a challenge for luxury brands, which generally like to sell direct to shoppers through their own stores or websites.

And China’s shoppers are used to cutting-edge mobile apps, making the technological nous of Alibaba and JD.com highly valuable.

Partnerships also help brands scale up quickly. UBS estimates that just 5% of luxury purchases are currently made via the web in China, compared with around one-fifth in the Americas region.

Amazon has less to offer in the more familiar, less buoyant U.S. market. Nor has the American giant bent over backward to cater for luxury, as Alibaba and JD.com have. The Chinese sites have launched separate platforms, keeping expensive handbags away from run-of-the-mill purchases.

Alibaba runs an invite-only loyalty club that uses an algorithm to identify big spenders, while luxury goods bought on JD.com are delivered by white-gloved men who must be “well educated” to land the job, the head of JD Fashion told the South China Morning Post.

The Chinese also offer attractive terms: Alibaba’s Luxury Pavilion takes a modest 5% cut of the sale price, according to UBS.

This news could be bullish for BABA. The stock is trading near the upper end of a trading range.

BABA daily chart

The longer-term chart shows a break out could be a set up for a large gain since the consolidation pattern has been in place for almost two years.

BABA weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying BABA could require a significant amount of capital and exposes the investor to standard risks of owning a stock.

To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.

Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.

To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.

This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.

bull call spread

Source: The Options Industry Council

Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.

A Specific Trade for BABA

Every day, we scan the markets looking for trades that BABA low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

For BABA, the April 18 options allow a trader to gain exposure to the stock.

An April 18 $190 call option can be bought for about $1.50 and the April 18 $192.50 call could be sold for about $0.90. This trade would cost $0.60 to open, or $60 since each contract covers 100 shares of stock.

The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $60.

The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.

For this trade in BABA the maximum gain is $1.90 ($192.50 – $190 = $2.50; $2.50 – $0.60 = $1.90). This represents $175 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $60 to open this trade.

That is a potential gain of about 216% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.