When a momentum stock like Amazon.com, Inc. (NASDAQ:AMZN) comes alive, it really doesn’t leave many clear points for entry. The rally in AMZN stock is so steep that it constantly appears ready for a dip, causing some would-be investors to sit on the sidelines and wait, while others hold their nose and pray.
Luckily, we have options.
Options allow us to avoid risking a thousand bucks per share to trade Amazon stock. Better yet, options allow us to structure trades that have ample room for error.
It’s almost impossible to convince most investors that Amazon is a bargain at $1,010 per share and a price-to-earnings ratio of 190. (Just 90 times forward earnings, though!) But I look back at the trajectory of its meteoric rise, and I also see evidence that the company’s fundamentals have since improved even further. Especially with the advent of Amazon Web Services, I can easily extrapolate that more upside in AMZN stock is all but assured in the next few years.
Click to Enlarge In other words, this can’t be a top!
But even though they’ve been fleeting, I can’t completely exclude the possibility of dips. So I don’t want to pay face value for Amazon without any room for error.
How to Trade AMZN Stock
The objective: I want to build an ownership in AMZN stock but at a lower cost basis than current price.
The asset: Buy the AMZN Jan 2018 $1030 call for $69 per contract. This puts me long Amazon for a fraction of the stock’s face value.
To mitigate my risk, I will not engage with a full position. Instead, I will lower my entry cost by selling downside risk to create income. When I sell puts, I commit to buying more shares but at a discount — much like the average-down concept.
The bank: Sell the AMZN Jan 2018 $850 put and collect $20 per contract. Here I have a 90% theoretical chance that I will retain maximum gains, which would lower my entry cost in the overall position by 25%.
Furthermore, when I own an asset, I like to put it to work for me. So I don’t let the Amazon calls that I bought sit idle. Instead, I can sell monthly covered calls for income. Any resulting successful round of this would reduce my overall entry cost in AMZN stock even further. For example:
The twist: Sell the AMZN 30 Jun $1050 call and collect $5. If it expires worthless for maximum gains, then I would have given myself an additional 7% discount for my January calls. I can repeat the process for even more discount opportunities.
Trading options is risky business, so only risk money you can afford to lose.
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.