A couple of weeks ago, a friend forwarded me this CNBC posting regarding an option trade for Alibaba (BABA) that was claimed to guarantee to make $2 million within 6 weeks by some followers. Here is what I said: This to me is just a gambling that if the trading goes through as expected, he/she can make max $2 million but it dose not, the total lose is unlimited.
This option strategy is so-called strangle that will make money if the underlying stock is only trading within a set boundary of prices prior to the option expiration. It may be a good way to make some quick money for slow-moving stocks but it is extremely risky for high-flying stocks for which their share prices can jump around significantly. It can easily wipe out one's account if no pre-defined exist strategy is set up. In this case, the guy is betting with really big money, 3000 contracts (equal to 300,000 shares). As I'm writing now, BABA is trading at $114. It means for each dollar beyond $102, the trader is loosing $300,000. At this moment of my writing, the paper loss for this guy is over $3 million already. Of course, it is hard to say this guy will definitely lose money as there are still 2 weeks to go before the option expiration on Nov 21. However, I think the odds are definitely against him/her. Since BABA has only started being traded for a few weeks, it is very difficult to do technical analysis. However, given how much euphoria around the stock lately and its price is above the Bollinger Bands with RSI over 80 (an overbought indicator), there is a good chance that BABA may decline a bit in the next 2 weeks. How much will it come down? No one knows for sure but I'd bet it is likely coming down towards its 10 day moving average around $104. If it happens, I'd think people who have not bought BABA yet will likely jump in to bid up its price again. It now all depends how lucky this guy will be in the next 2 weeks. I'm sure this guy will have many sleepless nights in the next 10 trading days.
The lesson? Do not play fire with options without sound exist strategy and pre-defining how much max money you can lose with a trade. It is exciting to make some quick money if everything goes well as expected but it can also easily wipe you out if you are not knowing what you are doing and the option trade goes against you.
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