Current consensus on Wall Street is that the trade in mega-tech stocks over. Traders are rotating out of them and into other laggard sectors like retail. I am not one to blindly follow the herd so I remain a skeptic.
While I believe that a rest for the mega-cap tech stocks sounds logical, I don’t believe that chasing losers is the right formula for success over the next few months. Since the macroeconomic thesis remains unchanged, instead of buying losers, I will add to bullish exposure into proven winners.
Amazon.com, Inc. (NASDAQ:AMZN) is one of those high-flyers who is resting. If you believe the media, you’d think it has already fallen into an abyss. The fact is that AMZN stock is 5% off its all-time highs. Furthermore and even after this dip, it still is up 50% year-to-date
I do recognize that technically, AMZN stock is precariously perched just above a trend neckline and if lost, it could target $1,091 per share. And that would be too close for comfort to the huge open gap left by the earnings rally.
Normally, pivot zones like this one instill confidence for me, this one is frothier than the usual. Markets didn’t spend enough time trading it so it has not had the chance to consolidate. This could make it too weak of a support zone. Nevertheless, it gives me something against which I can shoot.
Fundamentally, AMZN is not cheap. It has a price-to-earnings ratio that is at least 9 times that of Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB) and more than ten times that of Apple Inc. (NASDAQ:AAPL).
So it’s not cheap. That is why I will not risk $1,134 of my money to buy the shares and hope for a rally. Instead I will sell downside risk against levels that should provide support. And if they do, then I would generate income out of this air. Since AMZN is a momentum stock and it can move fast, I will leave plenty of room for error.
AMZN is part of the FANG gang, so they will trade as one unit for the most part. This makes them an easier target for media experts to propagate the meme to sell FANG and buy laggards. If I am successful with this setup then this very meme would have created income for me.
Even though Amazon stock is up 50% year to date, it still is below the average price target on Wall Street, so there is a reasonable chance of downgrades if this malaise persists. But I don’t think that the analysts have the guts to do it ahead of year-end.
AMZN stock is the mother of momentum stocks and it’s falling. Catching that machete can be dangerous, but is also fruitful.
The Trade: Sell the AMZN Dec 22 $1,050 put and collect $6 to open. This is a bullish trade that has an 85% theoretical chance of success. But if the price falls below my strike then I would own shares and accrue losses below $1,034.
Selling naked puts carries big risk, especially in a stock as expensive and as frothy as AMZN. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the AMZN Dec $1,067.50/$1,065 credit put spread. This has a slightly smaller odds of winning but a lot less money at risk. Yet if it wins, the spread would deliver 30% in yield.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free 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 as @racernic on twitter and stocktwits.