Amazon (AMZN) has been bouncing around in a nice range, which brings on a great trading opportunity. This options trade yields approximately 33% , with the expiration month in July 2012.
The Trade
Amazon currently trades around the $221 mark, with support near $206 and resistance around $234. I want to capture
time premium over the next 25-28 days by selling two out of the money options, one put and one call, and cover those short options with further out-of-the-money options. This trade is known as an iron condor.
I like this trade because Amazon is approximately equidistant between the two strikes, giving me room to adjust the position if necessary.
Call Spread | ||||||
Strike | Direction | Probability Expiring In The Money | Price | Credit | Delta | Delta Spread |
235 | Short | 17% | 1.52 | 0.67 | 0.19 | 0.07 |
240 | Long | 10.50% | 0.85 | 0.12 | ||
Put Spread | ||||||
Strike | Direction | Probability Expiring In The Money | Price | Credit | Delta | Delta Spread |
205 | Short | 19% | 1.68 | 0.57 | -0.17 | -0.06 |
200 | Long | 13% | 1.11 | -0.11 |
Key Points:
- The total credit brought in is $1.24 per contract
- $3.76 is at risk
- This represents a 32.9% ROI, net of fees, assuming both positions expire worthless in July
- I like selling these two options because they are just outside the support and resistance levels of $206 and $234
- The breakeven is $236.24 on the upside and $203.76 on the downside
Trade Risks
On the upside, Amazon has been fighting hard against Google (GOOG) in the smartphone space. Amazon recently released a new version of its Test Drive feature, which allows users to download one paid app per day, for free. Also, it allows users to try out apps before buying. For more on this, see my article: Amazon Slaps Google.
Also, Amazon could get a boost in price if positive news arises from gaining market share away from Apple (AAPL). Amazon's market share of the tablet market shrank to an abysmal 4% from 17% last year, but a turnaround in this number could cause trouble for Apple and would be a major boost to Amazon's upside.
I will be wary of any news from the retail sector. Particularly Wal-Mart (WMT). If Amazon releases any unexpected announcement about its retail side, those numbers will be compared to Wal-mart. Right now Amazon has a horrifically low trailing twelve month profit margin of 1.42%. If news erupts that Amazon is gaining new sales then the stock will rocket upwards.
On the downside, I am wary of the VIX because it is trading so low. If the market drops, the VIX will rise. This harms the trade for two reasons. First, our $205 put becomes a more risky play. Second, however, the VIX will rise, carrying implied volatility with it. This will increase the value of the options position, because they have become more volatile.
Also on the downside, Wal-Mart is winning the price war against Amazon. If this story catches on with traders, the stock could take a short-term tumble.
Finally, Rackspace (RAX) could come into play. Rackspace is a hosting company, and an announcement of an Amazon acquisition would noticeably increase Amazon's volatility.
Trade Management
Personally I prefer to do even lots of contracts so that a portion can be closed out to lock in profitability. If the trades lose 50% of their value (meaning a gain of $.62 per contract), then it can be a good idea to lock in some profits.
If Amazon does break past our breakeven points, traders must decide if it makes more sense to rollover to future months, to enter another trade, to hedge the delta in some way, or to take a loss.
Conclusion
Take this trade at your own risk. Amazon has swung wildly but has calmed for now. I do not recommend trades, I simply present ideas that I come across. Trade wisely.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
