After peaking on June 9, tech stocks rolled over and corrected about 5%. Since Amazon.com, Inc. (NASDAQ:AMZN) trades like a tech stock rather than a retailer, it too fell from its June high. It recovered, but now it’s on the slide again, and today I want to share a trade that will profit from this dip in AMZN stock, but won’t force us to chase a rally.
In fact, we’ll be able to build a sizable buffet just in case prices still have more room to fall.
Amazon Sentiment
AMZN stock has been a monster performer over the last decade, posting returns of more than 1,300% in that time. Amazon has a group of dedicated haters, but it’s small, thanks to the stock frequently decimating the short sellers.
Its fans are dedicated to the growth Amazon delivers. The green light to running up the stock really came when Amazon actually delivered profits thanks to its cloud service, Amazon Web Services. Still, even near $1,000 per share, buyers keep arguing for higher prices.
I somewhat share this sentiment. AMZN is an innovator that is not scared to try new things. And so far they have been rewarded with good things to come out of their ventures and so has the general public. But at these altitudes, I do have to trade Amazon stock with caution especially that the markets in general are also near all-time-highs.
While my last trade on AMZN was a short-term win, I prefer trading it on a longer time frame and with conviction. So today’s trade will be to generate income out of thin air by betting against the disaster scenarios of the bearish rhetoric of late.
Amazon stock could be the poster child of momentum stocks. It moves at breakneck speed in either direction and when it does it scares most traders out. AMZN as a falling knife is terrifying to catch especially at a $1000 price tag.
I like to sell risk against those fears for profit.
Fundamentally, I won’t argue that Amazon shares are cheap, since they trade at nearly 200 times earnings. But AMZN is not a value stock, so I’m more concerned with growth trajectory, not value. We’ve all heard the arguments that Amazon can’t do this forever, but I’ll believe it as long as I see it.
Under the leadership of CEO Jeff Bezos, management has altered industries and even invented a few new ones. It shocked the world by becoming the leader in the cloud with AWS, and everyone else is playing catch-up.
Click to Enlarge Technically, and even after a 5% dip, AMZN stock is still 35% higher than a year ago. So this hardly represents a correction. This is more like a mini dip but those have been fleeting. So today I will dare to commit long the stock through 2017.
No, I am not crazy enough to buy the shares at face value. I cannot risk $976 per share and without any room for error. Instead I will use AMZN options, where I can find proven support levels against which I can sell risk for income.
How to Trade AMZN Stock
The bank: Sell the $775 put and collect $10 to open. This trade has a 20% buffer, giving me a 85% theoretical chance of success. But if prices fall below my strike, then I have to own the shares and suffer losses below $765.
Amazon stock carries a hefty price tag. This limits many from selling naked puts as it comes with risk all the way down to zero. Instead I can use spreads to limit the exposure
The alternate trade: Sell the $775/$765 credit put spread where I have about the same odds of success but with a fraction of the risk. Yet I can still deliver 13% in yield. Compare this with buying AMZN stock then hoping it rallies to $1,100 just to match the performance of the spread.
Investing is always risky otherwise we’d have no reward. So I make sure that I never expose my portfolio to risk that I cannot survive.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
