Shares of Amazon.com, Inc. (NASDAQ:AMZN) have been on a major bull run over the past several weeks. AMZN stock briefly broke through the $1,700 level for the first time ever yesterday before pulling back to close at $1,695.75.
While I am not questioning the dominance of Amazon in nearly every market it enters, I am beginning to question whether the recent rally is due for a pause. I think a period of consolidation may be in the offing for AMZN stock.
Certainly any discussion of Amazon from a valuation perspective is an exercise in futility. AMZN stock has always been priced at extremes on nearly every metric — the current price-to-earnings ratio is an eye popping 275 — and will likely continue to be for the foreseeable future. Amazon is now the second-largest publicly traded company in the U.S., with the $823.84 billion market cap trailing only Apple Inc. (NASDAQ:AAPL).
Over the past year, AMZN is also the best-performing S&P 500 stock of the top 10 stocks by market cap, sporting a gain of 68%. This is more than double the strong 25% gains shown by AAPL in the same time frame. The rally may be heating up a little too much for Amazon.
AMZN stock is overbought on a 9-day RSI basis with a reading over 80. The previous two times this year the stock was this overbought proved to be significant short-term tops.
Yesterday was also the first down day after nine straight up days for Amazon.
Click to Enlarge More importantly, it was reversal day for AMZN stock. After trading to fresh new all-time highs above $1,700 ($1,714.50 to be precise), shares pivoted and sold off, ultimately closing lower on the day at $1,695.75. This type of price action is usually indicative that the rally may be extended and the buyers might finally be exhausted, especially after such a strong move higher. Factor in that the reversal occurred at the round number of $1,700 and it becomes an even more powerful signal.
Implied volatility (IV) in AMZN is at the 33rd percentile, meaning options are comparatively cheap but not overly so. This still makes option selling a viable strategy. So to position for a stall-out in the red-hot rally in AMZN, a bear call spread makes probabilistic sense.
AMZN Stock Trade Idea
Buy AMZN July $1,760 calls and sell AMZN July $1,750 calls for a $3.50 net credit.
Maximum gain on the trade is $350 per spread with maximum risk of $650 per spread. Return on risk is 54%. The short $1,750 strike provides a $54.25 upside cushion to the $1,695.75 Wednesday closing price of AMZN stock.
Amazon reports earnings on July 26, so the July 20 expiration means the options will expire before then and avoid the potential earnings based jump risk.
Tim may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his option-based strategies can go to https://marketfy.com/item/options-and-volatility/.