Consider The Reverse Iron Condor For Trading Amazon's Upcoming Earnings

Apr.11.12 | About:, Inc. (AMZN)

With all recent attention surrounding Apple (AAPL), Google (GOOG) and Priceline's (PCLN) earnings, another stock that will be interesting to watch this earnings season is Amazon (AMZN). Amazon is the largest online retailer in North America and the world's largest digital and print book seller. Amazon is also a large seller of consumer electronics; when consumers visit their traditional brick and mortar store, this can be thought of as Amazons showroom.

Where brick and mortar stores continue to face challenges, Amazon will always be there to pick up market share of brick and mortar stores that struggle. One brick and mortar store that has been struggling for a while has been Best Buy (BBY). With the consumer continuing to use the internet to price check and purchase items, Best Buy and other electronic retailers will continually have to adapt to a changing consumer. I believe in the long term Amazon will continue to dominate and take market share from brick and mortar retailers. I wouldn't throw a blanket over all the brick and mortar retailers, since some are in a better position than others, but for every brick and mortar retailer that struggles, Amazon can naturally pick up market share.

Earnings season can be an exciting time for option traders due to the many strategies that traders can employ to profit off companies earnings. Amazon can often have erratic earnings, and during the last year, Amazon has traded in the range of $180 to $240. Amazon's erratic earnings over the last four quarters can present difficulties for directional traders, but traders using a non-directional strategy have generally been rewarded without having to take a bullish or bearish only stance.

Earnings History Mar 11 Jun 11 Sep 11 Dec 11
EPS Est 0.61 0.35 0.24 0.17
EPS Actual 0.44 0.41 0.14 0.38
Difference -0.17 0.06 -0.10 0.21
Surprise % -27.90% 17.10% -41.70% 123.50%
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Source: Yahoo Finance

The most common non-directional option strategies include straddles, strangles and reverse iron condors. One of the great things about non-directional option trading strategies is that, as a trader, you get to play on both sides of the fence and are betting that an upcoming event can sharply drive a stock higher or lower. Amazon's earnings over the last four quarters have shown an average price movement up to the day before earnings of $10.24

Jan 17, 2012 close = 181.66 to Jan 30, 2012 close = 192.50 This is a $10.49 gain

Oct 5, 2011 close = 219.50 to Oct 24, 2011 close = 237.61 This is a $18.11 gain

July 1 ,2011 close = 209.42 to July 25, 2011 close = 216.52 This is a $7.10 gain

April 1, 2011 close = 180.13 to April 25, 2011 close = 185.42 This is a $5.29 gain

Source: Yahoo Finance

If investors believe there will be a run-up or run-down going into Amazon's earnings then here is a non-directional options play on Amazon.

Trade Idea: Reverse Iron Condor

Buy (1) May 19 2012 190 call = 9.35

Sell (1) May 19 2012 195 call = 7.05

Buy (1) May 19 2012 185 put = 8.00

Sell (1) May 19 2012 180 put = 5.95

Cost to do this trade = $435

Upper Breakeven Point = 194.35 (At 195 max profit is $295 per position)

Lower Breakeven Point = 180.65 (At 180 max profit is $270 per position)

Amazon reports earnings on April 24, 2012, so there is no need to rush into this trade. Amazon also has weekly options available if investors want to spend less to try and make more. Investors could also consider a straddle or strangle, but this would cost three times the amount of the reverse iron condor. At the time I am writing this article, Amazon is trading at $188, and by placing a reverse iron condor, investors are betting that Amazon will move $7 to $8 in either direction to be profitable. Seven to eight dollars sounds like a lot, but in reality, Amazon needs to move 4% from the current price level of $188 in 38 days. Over the last ten days Amazon has dropped over $17 per share, and doing a weekly reverse iron condor would have been profitable.

In conclusion, I don't want to bet on whether Amazon is going to beat or miss earnings, but would rather play the rise in implied volatility and exit out of the trade before earnings. There is plenty of time from now until Amazon's earnings to do a reverse iron condor for a favorable debit. As with any options strategy, there are advantages and disadvantages to using a reverse iron condor, but for Amazon, I believe that the reverse iron condor is the best way to go heading into earnings. I will be placing this trade using a hypothetical portfolio and will consider placing a reverse iron condor as Amazon's earnings near.

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