How to Play Amazon Stock After Surge
Amazon.com, Inc. (NASDAQ:AMZN) is up 34% this year, with a recent break of the elusive $1,000 price level. In the aftermath, we saw both upgrades and downgrades as investors are left to speculate on what to do next.
They could pay the current price for AMZN stock and risk a downside retrenchment or wait for a potential price dip to pick up shares at a more reasonable price.
With the consensus one-year price target at $1,115, many investors would likely find the decision a difficult one to make, but I’m going to give you some ways to play Amazon stock that make some sense, given the price situation.
AMZN stock trades at a hefty 88-times its 2018 earnings per share (EPS) and has a price/earnings to growth (PEG) ratio of 5.50. These metrics are not cheap, and account for perfect growth.
With the PEG, you would be paying 5.50-times the projected five-year compound annual growth rate (CAGR) for earnings, which is kind of ridiculous.
Now don’t get me wrong; I love the longer-term prospects for Amazon stock, as reflected by its acquisition of Whole Foods Market, Inc. (NASDAQ:WFM) and its numerous other projects that promise to disrupt the way many businesses operate.
Given that AMZN stock is trading around the $1,000 level, I’m going to show you some alternative ways to play Amazon, but with more manageable risk.
Playing AMZN Stock via Options for Profits
For some of you, the concept of trading options is familiar. But if it isn’t, then don’t worry. It really is not that difficult to understand basic option strategies.
Note that the following option trades are examples only, and shouldn’t be used as actual trading advice.
Also Read: AMZN Stock Is Headed to $2,000
My examples will be based on Amazon stock at $1,001 and on the 50-day and 200-day moving averages (MA) at $959.94 and $848.53, respectively. I will use the January 2018 expiry date for the AMZN stock options to allow time for the trade to pan out.
Put Option Strategy
You can sell put options on AMZN stock to establish a lower entry point while also generating premium income that is yours to keep, regardless of whether the trade is exercised. The premium will also lower your adjusted cost base for AMZN in case you are required to buy the stock.
Let’s say you believe that Amazon stock could fall to the 50-day MA at $959.94.
In this case, you would sell the Amazon January 2018 $945.00 put at the prevailing $46.85 per share or $4,685 for one put option contract (which represents 100 Amazon shares).
If Amazon doesn’t fall below the $945.00 strike by the expiry, you get to keep the $4,685 premium.
Chart courtesy of StockCharts.com
Now, assume that AMZN falls to $940.00. Under this scenario, you would have to buy Amazon at the strike price of $945.00. You are okay with this and, best of all, your adjusted cost base is around $898.15 after discounting in the premium received ($945.00 – $46.85 = $898.15).
So ultimately, you either earn $4,685 or have to pay $898.15 for Amazon stock, which are two pretty good alternatives. Of course, the risk is that if AMZN stock falls below $898.15 by the expiry, you would be in a loss position.
Call Option Strategy
Under this scenario, you are bullish on Amazon and feel that it will continue formally by the January 2018 expiry.
Check Out: Invest in Amazon Stock in 2017
Let’s look at the at-the-money $1,000 call option with the last trade at $79.75.
The breakeven is around $1,079.75, excluding commissions. Say AMZN stock hits $1,200 by the expiry. You would make $120.25 per contract ($1,200 – $1079.75 = $120.25), or profits of about 10%.
Say you feel that the upside is limited to $1,250 by the expiry date. Assuming this, you can initiate a bullish call spread by selling the $1,250 strike and gain some premium.
The trade would be:
- Buy Amazon $1,000 Call: $79.75
- Sell Amazon $1,250 Call: $12.50 Premium
- Net Cost: $67.25
The breakeven price is $1,067.25, with a maximum profit of $182.75 if Amazon reaches $1,250.