Taking Advantage Of Amazon's Lull With Bullish Spread

 |  About: Amazon.com, Inc. (AMZN), Includes: AAPL, BKS, EBAY
by: PowerOptions

Amazon.com (NASDAQ:AMZN) increased its worldwide revenue by 44% in the third quarter. The company also indicated it has 152 million active customer accounts.

Founded as an online bookstore in 1994 by Jeff Bezos, Amazon is currently an electronic commerce company that serves as the world’s largest online retailer. Amazon has free membership for basic customers, but also has a paid membership option—called Amazon Prime—which allows customers to receive free 2-day shipping (or 1-day shipping for $3.99) on all orders for a flat rate of $79.99 a year. There has been some speculation that Amazon Prime has been a thorn in the company’s side; however, as Ben Schachter of Macquire Equities Research points out, “Prime is NOT broken.”(pdf) For instance, Prime increases the number of individual orders a customer submits to Amazon because the customer does not have to worry about ordering several items at once in order to save on shipping costs; customers know that it is still financially feasible to submit multiple orders. This way, Amazon lets its frequent customers save on shipping while, in the end, making more money off of its Prime users.

In the past few weeks, though, Amazon has established itself as a fierce competitor in the tablet industry. According to Eric Caoili, Amazon has sold over 2 million Kindle Fire units since the tablet’s release in mid-November. In fact, at Best Buy (NYSE:BBY), the Kindle Fire outsold every other tablet—including Apple’s (OTC:APPL) iPad—on Black Friday of this year. The Fire, which is priced at $199, includes 8GB of storage, a 7-inch display, Wi-Fi capability, and several other useful features, which help give the iPad a run for its money. As of December 4, the Kindle was in second place in tablet sales behind the iPad, with a strong lead over tablets from Samsung (OTC:SSNLF), HTC, and Barnes and Noble (NYSE:BKS).

Amazon sees tough competition in all of its ventures, though it manages to hold its own very well. For instance, in the realm of online commerce, Amazon is faced with eBay (NASDAQ:EBAY), which was founded just a year after Amazon itself; however, Amazon consistently tops eBay in surveys and analyses of marketplace websites. In the online publishing industry, Amazon is squaring off against two relatively new competitors: The New Yorker and the Huffington Post. In late September, the Huffington Post published its second e-book, Aarok Belkin’s "How We Won," following Amazon’s announcement that George R. R. Martin (author of the "A Song of Ice and Fire" series) was the latest author to sell 1 million Kindle books. Amazon is not currently among the top 10 best online book publishing companies, so we’ll have to wait and see how well its e-book publishing ventures stack up against its competitors. Still, with the release of the Kindle Fire and the success of authors such as R. R. Martin, Amazon can be expected to perform well in this market.

Amazon’s other major source of competition could stem from rumors surrounding its development of its own smartphone in mid-November of this year. Of course, such a project would bring Amazon face to face with Apple yet again, and it is too soon to tell how well Amazon’s possible project will fare against the iPhone—the number one-selling smartphone in the world as of last quarter.

According to the company’s latest conference call, Amazon expects an increase in net sales between 27% and 44%. However, as Thomas J. Szkutak points out, it is difficult to accurately predict sales because there is no clear indicator of what future demand will be.

Amazon’s stock price is not too far off of its previous $160 support level experienced in March of 2011, as shown below:

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With Amazon near its previous support level, a bull-put credit spread looks attractive. A bull-put credit spread is entered by selling a put option and purchasing another put option further out-of-the-money. The trade can be entered for a net credit with the net credit retained as income or profit.

Using PowerOptions tools, an attractive bull-put credit was found with a 7.7% potential return and a timeframe of 43 days for realizing the potential profit. The specific put option to sell is the 2012 Feb 150 Put at a midpoint price of $1.67 and the put option to purchase is the 2012 Feb 135 Put at a midpoint price of $0.61. A profit/loss graph for one contract of the Amazon bull-put trade is shown below:

The short put strike of $150 is 18.5% out-of-the-money and is below the previous $160 support level. If the price of Amazon’s stock drops to around $165, the position should be exited or rolled further out in time. If the price of Amazon stock is greater than the $150 short strike of the put option at options expiration in February, the options will expire worthless and the position will return 7.7%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.