Amazon (AMZN) stock has rallied off the December lows and is now above a rising 21 and 50-day moving average. While the stock has pulled back in recent days, I’m willing to bet that it stays above 82 between now and February 3.
Keep in mind that Amazon is due to report earnings on February 2nd.
I’ll be looking at a strategy called a diagonal put spread. This option strategy is an advanced strategy because it utilizes options over different expiration periods and different strike prices.
The strategy involves selling an out-of-the-money put for a near term expiry and then buying a put for around the same price using a later expiry.
The idea with the trade is that the stock might fall a little, but should stay above the short strike price.
Let’s look at an example using Amazon.
Amazon Diagonal Put Spread Example
The trade I’m looking at is selling a February 3rd put with a strike price of 85 and buying a February 17 put with a strike price of 80.
As of yesterday’s close, the February 3rd put could be sold for around $1.25 and the February 17th put could be bought for 1.00.
The trade would result in a net credit of $25.
The risk on the trade is on the downside with a potential maximum loss of $475. This is calculated by taking the difference in the spread (5) multiplied by 100 and subtracting the premium received (25).
The maximum potential gain is around $200 which would occur if AMZN closes right at 85 on February 3.
The trade has a nice profit zone in between 82 and 98.
Aiming for a return of around 10-15% makes sense and I would set a similar stop loss.
The worst-case scenario is a sharp drop in AMZN stock early in the trade. For this reason, if the stock drops below 85 in the next few days, I would also consider closing the trade early to minimize losses.
The initial trade set up has a delta of 5 meaning the position is roughly equivalent to owning 5 shares of AMZN stock. Note that this delta number can change significantly as the stock starts to move.
Below is the payoff graph with the blue line representing the profit or loss at expiration and the purple line being the trade as of today.
This is how the trade could look in around ten days time.
So, provided AMZN stock stays above 85 in the next ten days, the trade should be ok. As the trade requires the stock to not drop too much, this would not be an appropriate strategy for bearish traders.
Amazon Company Details
The Barchart Technical Opinion rating is a 56% Sell with a Weakening short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
Amazon.com is one of the largest e-commerce providers, with sprawling operations spreading across the globe. Its online retail business revolves around the Prime program well-supported by the company’s massive distribution network. Further, the Whole Foods Market acquisition helped Amazon establish footprint in physical grocery supermarket space. Amazon also enjoys dominant position in the cloud-computing market, particularly in the Infrastructure as a Service space, thanks to Amazon Web Services, which is one of its high-margin generating businesses. Amazon has also become a household name with its Alexa powered Echo devices. Artificial Intelligence backed Alexa is helping the company sell products and services. The company reports revenue under three broad heads’ North America, International and AWS, respectively. Amazon targets three categories of customers – consumers, sellers and website developers.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
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On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.