Last week saw the start of a violent mega-cap roll over that continues to sweep tech giants like Amazon.com, Inc. (NASDAQ:AMZN). AMZN stock now trades roughly 6% below its closing price on Thursday, which is almost an official correction.
On Friday, Amazon’s price chart candle covered that of the last 28 daily bars. It also priced all that range’s rally effort. If markets in general stabilize, this could be an entry opportunity into a short-term AMZN trade.
No, I won’t risk $950 buying the stock, but instead I will sell short-term downside risk against levels that I see as support. The fact that they are short-term makes today’s setup speculative. So I only risk what I can afford to lose without breaking my piggy bank or my heart.
Trading AMZN While It’s Down
Up until Friday, Amazon’s rally was one for the ages, especially for a four-digit stock price on a mature company. I often say that momentum like Amazon’s doesn’t leave investors many easy entry points. It rallies so fast that they constantly seem ready for a dip. Then when the dip comes, like Friday and Monday, very few see it as an opportunity. Most traders again opt out thinking it’s a falling knife with no bottom.
The solution is to study the market setup. If I know where markets expect AMZN to go in the short term, then I can evaluate the active level versus what’s built into the market. This week’s open interest suggests that AMZN will find footing as long as markets in general hold the recent lows. Therefore, I can take a short-term bullish trade to scalp some fast profits. But since this is short-term risk, I have to treat it as highly speculative.
Using options, I can avoid risking $950 per share and structure setups with some room for error. I can even add a bearish side for balance.
Even after this dip, it’s hard to convince investors that AMZN is a bargain. It carries a very high price-earnings ratio of 190. Sure, looking forward the P/E ratio is nearly halved, but most prefer looking back than betting on future growth. I like to look forward, especially when Amazon’s fundamentals continue to improve. Web Services is a monster opportunity that has legs.
The Short-Term Thesis: AMZN will hold the recent lows, so I want to create potential income from selling downside risk against it.
The Bet: Sell AMZN 16 June $935/$932.50 credit put spread. This is a bullish trade that has a 80% theoretical chance for yielding 30% on risk. If price falls below my spread, I would suffer losses.
I like selling put spreads in stocks I like because if things go wrong I have options. The maximum loss is well defined as width of spread (-) the premium I collect. Or I can opt to own the shares and keep my premium. Then if I like AMZN long term, it wouldn’t be a disaster owning its shares in this uber-bullish market.
I usually like to balance my trade by selling upside risk too. This would turn my credit put spread into an iron condor. Amazon, however, is a monster stock that could sting on the upside, so I hesitate to take the credit call spreads. Nevertheless, the setup is available.
The Hedge (Optional): Sell AMZN 16 June $1000/$1002.50 credit call spread. This is a bearish trade that has a 80% theoretical chance of yielding 30% on risk. If markets are stable on Monday I would delay entry here unless I see market-wide weakness.
I also need to watch the price action in other mega caps as often the group moves in sympathy. So it’s important to keep tab on what Apple Inc (NASDAQ:AAPL) and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) are doing.
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.
