Shares of Amazon.com, Inc. (NASDAQ:AMZN) have been on a tear since reporting better-than-expected earnings last month. Counting the earnings gap ,AMZN stock has risen 23% in the past two weeks, recovering much of the ground lost in last year’s downturn.
While some shareholders are no doubt basking in their good fortune, others may be wondering if there’s a way to lock in the recent gains while remaining open to additional upside in AMZN stock. The latter group will find today’s article of particular interest. The options market provides an effective strategy for accomplishing both objectives.
It’s called the stock replacement strategy.
As the name suggests, the stock replacement strategy is designed to morph a long stock position into something that provides similar exposure but for a pittance of the cost. Right now a 100-share position of AMZN stock requires a hefty $37,000. While you enjoy unfettered participation on the upside you also have $37,000 of theoretical risk to the downside.
Suppose we sold the long shares of AMZN and replaced them with a long April 335 call option. The call cost of $4,259 is only 11% of the capital required for 100 shares of AMZN. While the risk in the position has been greatly reduced, the ability to profit from additional gains in shares of Amazon remains untouched.
The only slight difference is how quickly additional gains will be captured. The long 100-share position had a +100 delta, granting an additional $100 of profit for each $1 increase in AMZN shares.
The long April 335 call, in contrast, has a delta of +80 which means you will initially only capture an additional $80 of profit for each $1 increase in AMZN. Keep in mind, however, as AMZN stock continues to rise, the April call will move deeper in the money, causing the delta to eventually increase to +100.
One additional variable increasing the appeal of a stock replacement strategy for AMZN stock in particular is the low implied volatility. In light of the post-earnings volatility crush, the IV Rank for AMZN rests at a lowly 18%. The low implied volatility means options can be purchased on the cheap, making long calls an even more attractive alternative in this scenario.
If you’re looking for longer-term exposure to AMZN stock, simply swap out the April calls with those that expire in a later month such as July or even Jan 2016.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
