If I told you that there is a startup company that crushes its competition in dozens of industries and it’s profitable, would you short it? I wouldn’t.
There was a time where I’d hear dozens of investment experts brag about their short positions in Amazon.com, Inc. (NASDAQ:AMZN) stock. They argued how the company couldn’t maintain its operation at such thin margins for long.
They were all waiting for the imminent collapse which of course never came.
Click to Enlarge The AMZN stock staunch bears failed to understand the difference between running thin margins and burning cash to operate. Bezos was over-spending chasing dreams, but with money that he could afford to spend. Meaning it generated its own cash to cultivate new income streams. He proved his critics wrong and as a result he demolished entire industries — none more famous than brick-and-mortar retail. Just ask Macy’s Inc (NYSE:M) and alike.
But most impressive was Amazon’s dominance in what we now call the cloud. Out of nowhere, AWS surged into the lead in could services leaving everyone else like Microsoft Corporation (NASDAQ:MSFT) scrambling to catch up.
I confess that a nearly 200 price-to-earnings ratio is hard to argue as cheap but given the growth the company can deliver who knows what’s the real value in the stock lies. I’d rather own AMZN at a 200 P/E than, say, Chipotle Mexican Grill, Inc. (NYSE:CMG) at 100. So for now, I still evaluate Amazon as a growth start-up company.
This leaves me to trade the price action in AMZN stock not its valuation. Given what I said about the company already, I don’t short it, so I’m left to buy the dips.
No, I don’t like to risk $1,025 per share and hope for perfect timing. At that price, it’s hard to have strong conviction on dips. So I use AMZN options instead. There I can build price buffers to give me the intestinal fortitude necessary to navigate the short term price gyrations while in my trades.
Reactions to earnings can be violent, especially for momentum stocks like AMZN just look at what Netflix, Inc. (NASDAQ:NFLX) stock did recently. On its last earnings dip I went long AMZN against the Wall Street selloff and within weeks it had set records higher. This time I am willing to set the risk ahead of time and bet long again. I emphasize the word ‘bet’ so I must have a contingency plan.
I will sell downside risk and collect a premium. If the stock stays above my strike, then I keep my premium for maximum gains. This means that I am long AMZN with no money out of pocket. My only cost is the risk of ownership at a discount.
AMZN Stock Trade Idea
The Bet: Sell AMZN Sep $900 puts and collect to open $5. Here I have a 90% theoretical chance of success. But if it falls below my put I accrue losses below $895.
Selling naked puts in such an expensive ticker requires substantial margin to secure the trade. So I can mitigate the risk by selling a spread instead. There, the risk is limited to the width of the spread less what I collect.
The Milder Bet: Sell AMZN Sep $900/$895 bull put spread where I have the same chance of success but with less money at risk. Yet if the spread wins it delivers 10% in yield.
Someone who really wants to be bullish AMZN can use the proceeds to buy a call position into earnings for even more potential profits. Just keep in mind that this would change the breakeven point on the puts sold.
The Juice (Optional): Buy AMZN Sep 1 $1,030/$1,032.50 debit call spread for $1.20. It is important to note that I don’t need a rally in AMZN to profit. As long as price stays above my strike, any premium I recapture from selling my calls would be incremental profits.
There are no guarantees when investing in the stock market so I never bet more than I am willing to lose.
Learn options as easy as 1-2-3 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.
