Shares of Amazon.com, Inc. (AMZN) held critical support at the $600 level, and I look for that level to hold on Amazon stock over the next several weeks.
After reaching a new all-time high of $696.44 on Dec. 29, Amazon stock sold off sharply, dropping nearly $100, or 14%, and briefly trading below $600 at $598.57 on Jan. 11.
Amazon stock, which was deeply oversold from a nine-day RSI viewpoint, rebounded quickly to close at $617.89 yesterday. This type of reflexive rally normally signals a short-term low is in place.
Implied volatility (IV) also had spiked sharply, which is another good indication that the selling pressure may be exhausted.
The Amazon Stock Charts
Click to EnlargeAMZN stock has a classic island formation from a technical standpoint, meaning the stock gapped higher following the last earnings report and has held that level ever since. You can see from the chart why it is referred to as an island, with the distinguishable separation resembling an island.
It was important for AMZN to hold the $600 support level to avoid a bearish island reversal.
In my previous article on AMZN following the last earnings report, I noted the difficulty Amazon stock may have moving appreciably higher, given the law of large numbers coming into play. My viewpoint hasn’t changed much since that time, and I still look for AMZN to remain range-bound until earnings on Jan. 28.
Using a longer-term chart, it is evident that Amazon stock likes to go “island hopping” following earnings, and I would expect a similar scenario to play out again.
Click to Enlarge With earnings on Jan. 28, I want to position with an expiration before then to reduce the risk. Elevated IV levels favor option selling strategies, so selling an out-of-the-money put spread below the $600 support level and with an expiration before Jan. 28 makes sense.
Specifically, I would sell the AMZN Jan 22 $590 puts and buy the AMZN Jan 22 $585 puts for a 70-cent net credit. These options expire just in front of the AMZN earnings date.
The $590 strike is also positioned below the $600 support level on AMZN stock.
The maximum gain on the trade is $70 per spread, with the maximum risk of $430 per spread. Return on risk is about 16%.
I would close out the spread on a meaningful move through the $600 support level, while looking to have the spread expire worthless and keep the initial credit if Amazon stock remains well-behaved.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
