They say insanity is doing the same thing and expecting a different outcome. Bears keep trying to short Amazon.com, Inc. (NASDAQ:AMZN) even after a decade of being wrong still expect to be right. AMZN stock is down this morning, but I bet that even in the short-term, they’re wrong again this time.
Amazon reported disappointing profits last night, and the stock is down more than 3% Friday morning in response. The main concern is spending … so what else is news? I don’t think you can accomplish what AMZN has without spending a lot, and most of Wall Street agrees.
What pundits keep missing is that startup companies need to overspend. “Amazon isn’t a startup,” you say. False. Amazon still is a startup growth company because it’s perpetually entering new ventures. We still don’t need Amazon to be profitable, and yet, Amazon is profitable!
Click to Enlarge When Amazon stock fell to $800 on the February earnings report, I not only went long Amazon, but went on record saying it would climb $900 within weeks. Now here we are with the bears celebrating its fall to $1,010.
So, what do we do here? Same as always – buy the dip in AMZN stock!
I don’t buy into stocks and merely hope they rally. But when I see upside potential, I like to sell risk below levels that other people fear. For my risk, I collect a premium, and if I am right I keep it without ever owning any shares. I just bet on support levels holding, and where I place my risk determines how much premium I collect.
The closer we bet to the current price, the more risk I take on, thus the more premium I collect. But I also prefer to leave a big margin for error to the point that leaves me with 80% statistical odds of success or better.
Today isn’t an argument about value in AMZN stock. Amazon clearly is expensive, but Wall Street pays a premium for future prospects. And this company’s future is massive. Amazon boasts extreme growth in a multitude of industries that are not even tied to each other. Its latest success is in cloud services, making this e-tailer diversified even though it’s an extremely aggressive operator.
There’s always a risk of deep correction when a stock trades at 200 times earnings. I know that a 3% dip here isn’t a chasm, so it may not be the bottom of this wave. But given today’s fear, I bet I can build a buffer big enough to outlast the selling.
I also have to account for two more threats.
The first is from a market-wide equity correction. Markets are stretched thin and are vulnerable for a correction sooner or later. And the second is that expectations are too high for AMZN. So this deflation may take some time to work itself out. After all, this is a stock that is 35% higher than 12 months ago even after this dip, so there is definitely room to the downside.
How to Trade AMZN Stock
The Bet: Sell the Dec $820 puts for $8 per contract to open. This is a bullish trade where I have an 85% theoretical odds of winning. I need price to stay above my strike so I can keep the whole premium as maximum gains. Otherwise I would accrue losses below $812.
Selling naked puts in Amazon stock requires hefty margin requirement to secure the trade. I can moderate the risk by selling a spread instead. By buying an equal number of puts below the ones I sell, I limit the total dollars at risk.
The safer Bet: Sell the AMZN $820/$815 credit put spread. Here I can yield 10% but without the massive risk. Compare this with buying the shares around $1,000, then hoping for a rally higher when the markets are already near all-time highs. Sounds a lot better, doesn’t it?
Selling options is risky business, so never risk more than you are willing 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.