Amazon (NASDAQ: AMZN) finally had a pullback after breaching the trillion-dollar market cap mark for the first time ever. AMZN stock is still up over 70% year to date even after the 2.2% drop yesterday. While I’m certainly not questioning the dominance of Amazon in the internet commerce space, I am questioning whether the recent red-hot rally has reached a short-term extreme. Now that the upside momentum has finally waned, I look for AMZN stock to consolidate over the coming weeks.
Click to Enlarge Any discussion of Amazon from a traditional fundamental methodology is somewhat meaningless, especially when measuring against other stocks. A comparative analysis versus historical valuations of Amazon itself, however, can be enlightening.
AMZN stock now sports its highest price to sales ratio (P/S) over the past 10 years at nearly 5. It is also the first time P/S for Amazon was more than double the P/S for the S&P 500. Similar metrics, such as price to book and price to cash flow, are also at extremes. One thing that can be said is that comparative valuations are certainly not cheap, especially for a trillion dollar stock.
The technical picture paints a similar story of extremes. The 9-day RSI reached an overbought reading over 85. Previous times when AMZN stock reached such euphoric levels proved to mark a short-term top in the stock. Bollinger Bands were pierced to the upside as well, peaking at nearly 105 before yesterday’s pullback.
Click to Enlarge Amazon was also trading well above the widely followed 50 day moving average of $1838.31. Prior instances when AMZN traded at such a large premium usually led to a pullback in the shares.
AMZN stock also failed to reach a new high yesterday and closed on the lows of the day below the $2,000 level. This type of price action many times is indicative that the buyers may finally be exhausted, especially after such a huge rally.
Implied volatility (IV) spiked yesterday due to the sharp drop in Amazon and is back at the 47th percentile. This makes options comparatively more expensive and option selling strategies more viable. So to position for a period of consolidation in AMZN stock, a call credit spread makes sense. My previous post on AMZN recommended a similar strategy, which proved to be profitable.
AMZN Stock Trade Idea
Buy AMZN Oct $2,155 calls and sell AMZN Oct $2,150 calls for a $1 net credit
Maximum gain on the trade is $100 per spread with maximum risk of $400 per spread. Return on risk is 25%. The short $2,150 strike is positioned well above the all time high of $2050.50 and provides a 7.77% upside cushion to the $1,994.82 Wednesday closing price of AMZN stock.
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.