Trader's million-dollar protection on Alibaba

Alibaba shares are up some 45 percent from their IPO price. And in a massive options trade ahead of earnings, one big Alibaba holder appears to be looking to protect those gains ahead of the event.

On Tuesday, against a purchase of 500,000 shares of stock, one trader bought 10,000 protective Alibaba "collars" for $1.00 per share. One constructs a collar by purchasing a downside put and selling an upside call. Against a long position, this type of trade allows a trader to get protection on the downside, in exchange for capping profits on the upside.

Specifically, in this massive Alibaba trade, the trader bought 10,000 Nov. 7 weekly 94-strike puts for $2.40 per share, and sold 10,000 November 110-strike calls for $1.40 per share. This means that by shelling out $1 million in premium, the trader has protection below $94 through Nov. 7, but misses out on profits on the stock above $110 through Nov. 22.

Alibaba Group rings the opening bell at the New York Stock Exchange on Sept. 19, 2014.
Adam Jeffery | CNBC
Alibaba Group rings the opening bell at the New York Stock Exchange on Sept. 19, 2014.

"This was actually the biggest trade since Alibaba options were listed in September," Dan Nathan of RiskReversal.com said Wednesday on CNBC's "Fast Money." "To me, if you have 45 percent gains, let's say you got a good chunk of this on the IPO, this makes sense to protect in front of a potentially volatile event."

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Alibaba is set to report earnings for the first time on Nov. 4, and Nathan notes that "we don't know what to expect when this company reports," which has driven Alibaba options prices considerably higher.

So ahead of the earnings report, a collar like this "makes sense if you have big gains into a potentially volatile event," he said.

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