Soon after Amazon.com (AMZN) reported earnings last Tuesday, I wrote a post concluding that AMZN stock was worth a buy as soon as the stock opened for trading on Wednesday. This recommendation was not based on the discount the market was offering (at the time around 10%). Instead, it was based on AMZN's post-earnings trading behavior over the past three years; I did not go back further because I think of the pre-2009 market as a much different trading environment for earnings-related trades. I provided stock charts of each of the past twelve pre- and post-earnings reactions as evidence for the following simple trading rule:
Buy the open and hold for at least two weeks UNLESS the stock closes below the low of the first day of trading.
I chose the two week span arbitrarily, figuring it gave enough time for volatility to play out and send AMZN in the direction that most market participants preferred in the immediate aftermath of earnings. Two weeks seemed long enough to enhance profits on a winning trade, but short enough to keep risk exposure tolerable for such a short-term trade. Thus, two weeks is NOT necessarily an optimal holding period. I also chose one timeframe to keep the rule simple. Simple rules are easier to understand, modify and execute.
Now, as promised, here is a quantitative justification for this trade. The chart below summarizes the results (click for larger view):
Summary of Results from Trading Amazon.com the Day After Reported Earnings
Source: Price data from Yahoo!Finance
Here is an explanation of the various fields:
- Post-earnings trading date: the day after Amazon.com reported earnings. Amazon delivered each earnings announcement in this three-year sample after the market closed for trading.
- Stock price: the open, close, high, and low stock prices are recorded on the post-earnings trading date.
- 2-week return, NO stop loss: the percentage return, positive or negative, from buying the open or the close on the post-earnings trading date and selling exactly two trading weeks (10 trading days) later with no stop loss.
- Stop loss date: the date at which AMZN FIRST closed below the low of the post-earnings trade date. If AMZN never tripped this trigger in the two weeks of trading, I left the cell blank.
- Stop loss price: the closing price for AMZN stock on the stop loss date.
- 2-week return, WITH stop loss: the percentage return, positive or negative, from buying the open or the close on the post-earnings trading date and selling exactly two trading weeks later. If the trade stops out before two weeks, then the return is measured up to the stop loss date.
- Aggregate return: A sum of the percentage returns in the related columns. This trading strategy delivers these returns if profits are NOT reinvested into additional trades and the same amount of money is invested for each trade. This calculation makes it easier to understand the differences across these particular trading strategies.
Note the following observations from this table:
- Both strategies, buying on the open or the close, have a 7-5 win-loss record (in my last post, I reported slightly different numbers after eyeballing the charts).
- Buying the open performs dramatically better than buying the close because of three trading cycles where buyers took AMZN much higher from the open on the very first day of post-earnings trading. This behavior means that while buying the close "feels" safer because much more is known about the market's assessment of earnings, traders pay the price for such safety with much lower returns.
- The stop loss rule does not terminate any trades that would have otherwise delivered positive returns at the end of two weeks. By cutting losses early, this rule significantly improves the performance of both trading strategies (buying the open or close). Note well that this result also means that AMZN should not be shorted post-earnings UNTIL the stock closes below the low from the post-earnings trade date. I did not examine any bearish post-earnings trading rules for AMZN.
So far, so good on trading last week's earnings. After a small hiccup, AMZN was off to the races again after opening down as much as 10% in the wake of earnings. I was in experimentation mode with this trade, so I tried multiple approaches. I bought weekly call options ($180 strike) that expired the following Friday (February 3, 2012). In case AMZN soared quickly, these calls would give me very high leverage…which they did. I bought a $180/190 call spread expiring February 18, right outside the two-week trade window. This configuration provided me the majority of the upside potential according to the historical record with limited downside risk and cost. Finally, I bought a small number of shares in case AMZN meandered along and gave me reason to hold past the two-week timeframe. The Feb 3, expiration forced me to sell the weekly call well-ahead of the two week schedule. I also sold my shares into the quick run-up given the increasing risks of an over-extended, overbought stock market. I am still holding the call spread. (I post these kinds of trades on my twitter feed using the #120trade hashtag and user name "DrDuru").
The biggest irony of discovering this bullish trading pattern is that I have been mainly bearish on AMZN ever since it broke below its 200-day moving average (DMA) in late November. The continuing downtrend from that breakdown has finally ended, but AMZN has still yet to reclaim this critical support/resistance level. AMZN has not spent this long trading under its 200DMA since the sell-off in mid-2010.
(Click charts to expand)
Despite the impressive post-earnings bounce, AMZN remains stuck in a bearish pattern for the intermediate timeframe
Finally, I reproduce the pre/post-earnings charts that inspired this trade. Refer to the previous post for more details.
Source for charts: stockcharts.com
Be careful out there!
Disclosure: Long AMZN call spread