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Hedging AMZN

|Includes:Amazon.com, Inc. (AMZN)

**Update: AMZN posted earnings after Blain's article, and its shares rose after hours and are up about 5% as of Wednesday Afternoon. The post below has been updated with optimal hedges as of Wednesday afternoon.**

Is Amazon Headed to $175 Per Share?

In a recent article, Seeking Alpha contributor Derek Blain made a short case against Amazon (NASDAQ:AMZN), with a price target of $175 -- about a 36% drop from AMZN's current price. For AMZN longs who want to stay in the stock, but are considering adding downside protection, here are two ways to hedge the stock against greater-than-20% drops from its current price over the next several months.

Why Consider Hedging Against A >20% Drop

A twenty percent decline threshold is worth considering here, because it lowers the cost of hedging somewhat (all things equal, the larger the potential loss you are looking to hedge against, the less expensive it is to hedge), and because a 20% decline is not necessarily an insurmountable one. To recover from a 20% loss, an investor would need a 25% rebound in his stock. But to recover from a 36% drop (Blain's target) would require a rebound of nearly 56% in AMZN.

Two Ways To Hedge AMZN

The first way uses optimal puts*; this way has a cost, but allows uncapped upside. These are the optimal puts, as of intra-day Tuesday, for an investor looking to hedge 1,000 shares of AMZN against a greater-than-20% drop between now and July 19th:

As you can see in the screen capture above, the cost of those optimal puts, as a percentage of position, is 2.93%. By way of comparison, the recent price of the same level of downside protection on large cap tech co. Oracle (NASDAQ:ORCL) was less than 1% of position value.

An AMZN investor interested in hedging against the same, greater-than-20% decline between now and July 19th, but also willing to cap his potential upside at 15% over that time frame, could use the optimal collar** below to hedge instead.

As you can see at the bottom of the screen capture above, the net cost of this optimal collar is negative - that means that the AMZN investor would be getting paid to hedge in this case.

*Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D to sort through and analyze all of the available puts for your stocks and ETFs, scanning for the optimal ones.

**The algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University, and is currently available on the web version of Portfolio Armor.

The screen captures above come from the latest build of the soon-to-come 2.0 version of the Portfolio Armor iOS app. Optimal collar capability will be available as an in-app subscription in the 2.0 version of the app.

Stocks: AMZN