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Jack Ma - Founder and executive chairman of Alibaba Group.

We have long advised investors to build a position in Alibaba Group Holding by selling puts. The Chinese Internet giant, we have averred, offers a play on that nation’s emerging middle class, which should prove to be one of the 21st century’s most powerful economic forces.

If you listened and stayed steady during Alibaba’s (ticker: BABA ) stock swings -- which could have caused even the most disciplined investors to panic -- you likely find yourself in an enviable position. You effectively got the options market to pay you for establishing a stock position at sharply lower prices in one of China’s most intriguing companies.

In essence, the trade allowed you to take advantage of the widespread fear that existed regarding Alibaba, driving up put prices. By selling those puts, you telegraphed to the market that you were willing to buy the stock at a lower price. If the stock declined below the put, you got to buy it. If the stock advanced, you got to pocket the money for selling the put. Put options give investors the right to sell shares of a company at a set price before a set expiration date.

Our most recent recommendation, for example, to sell Alibaba’s January $70 puts for $5.05 ahead of Alibaba’s first-ever analyst meeting when the stock was at $76 produced a tidy profit. Shares are now around $98, and the puts are at offered at 70 cents, representing an extraordinary profit in just two months.

Since then, more investors seem to now regard Alibaba as a growth stock. The company last week reported extraordinary second-quarter earnings. Revenue increased 59%, and earnings increased 33%, compared to the year-ago quarter. Results exceeded analyst expectations, and the stock popped on the news, a signal that few investors were properly positioned into earnings.

In May, we advised investors to position for the report by selling August $75 puts for $3.25 when the stock was around $79.The puts are now offered at around four cents.

The earnings report likely has investors contemplating how to play catch-up with a company that is emerging as a must-own growth stock. Shares are up about 21% this year.

While we still like selling puts on Alibaba, we want to evolve our approach. It’s time to buy call options in anticipation that investors will start adding Alibaba to their portfolios. Calls give investors the right to buy a specific stock at a set price within a specific period.

With Alibaba’s stock around $98, investors can buy the November $105 call that was offered around $2.87. At $110, for example, the call is worth $5.

The November expiration covers Alibaba’s Nov. 11 “Singles Day” shopping event, which should be a stock-moving event. The expiration may even capture third-quarter earnings, which have yet to be announced.

Though the call-trade thesis is reasonable, it is important to understand the risks. If Alibaba trades at $110, the stock will have entered a new trading range at a time when the broad market is locked in a narrow range. Over the past 52 weeks, shares have ranged from $57.20 to $98.35.

The call trade is predicated on stock analysts beating their bullish tom-toms and sales traders peddling a new idea to clients who desperately need to catch up with their benchmark indexes before annual bonuses are set.

The views across the Street are bullish. Morgan Stanley sees shares hitting $130. Raymond James likes $124. Goldman Sachs is at $120, and added Alibaba to its Asia Pacific Conviction buy list, which represents the bank’s best investment ideas.

While those price targets are constructive signs, Alibaba’s options trading patterns are closely tracking the stock. Popular call strikes are just above the stock price.

This may bearishly suggest that investors think Alibaba is poised to consolidate its recent gains, especially after a 7% pop on earnings. Conversely, trading patterns may bullishly suggest that investors are about to chase the stock higher, eager to own a company that has figured out how to do what most companies cannot: grow revenue and earnings.

Alibaba’s open interest stands around 1.67 million contracts -- 986,000 calls and 689,000 puts. The top three contracts are the January $95 calls, the January $100 calls, and the January $90 calls. We would prefer to see some top positions in calls with higher strike prices. As of yet, that has not happened, but we don’t mind being early to this trade. How to Play Catch Up to Alibaba’s Surprise Rally


