Name That Trade(s) – $AMZN Primed

by Dan July 23, 2015 1:03 pm • Commentary

Event: AMZN reports Q2 results tonight after the close, the options market is implying about a 10% one day move which is a tad shy of the 4 qtr avg move of 11.5%.

Price Action / Techncials: AMZN’s 100% gains off of its 52 week lows, and its 55% year to date gains has placed the stock in top five of the Nasdaq 100 by weight, behind AAPL, GOOG, MSFT and FB.

The massive breakout in the stock to new all time highs back in April was met with a very healthy consolidation until earlier this month when the stock broke above the April high and went parabolic to the tune of 10% for no reason whatsoever:

AMZN 2yr chart from Bloomberg
AMZN 2yr chart from Bloomberg

The stock is clearly in uncharted territory, with no overhead resistance, but obvious support back at the consolidation level of $420 to $435.

Sentiment:  Despite the eye-popping year to date gains, Wall Street analysts for the most part remain sanguine about the stock with 35 buy ratings, 12 holds and 1 sell with an average 12 month price target of $496.  Short interest is a mere 1.5% of the float.

Valuation:  Let’s put some things in context.  AMZN’s $225 billion market cap, is within $10 billion of WMT’s, which has to be the closest ever for the two (WMT is down 20% from 2015 highs, AMZN is up 70% from its 52 week lows).  An investor in WMT is expecting to see net income of $16 billion on $506 billion in sales in 2015 vs AMZN expected to have $1.5 billion in net income on $103 billion in sales.  WMT is expected to have 5x the sales of AMZN and 10x the net income with both sporting about the same market cap. On the bright side, EBITDA is expected to grow 80% this year to $9 billion, but while this growth demonstrates the company’s ability to be profitable (when it wants to be), it could also be something to shoot at for the bears as those expectations could be too aggressive.

As usual when discussing AMZN, something seems just a tad unhinged here.

Volatility Snapshot:  Short dated options prices are at 52 week highs, at greater levels then prior to the last 4 earnings reports, while realized vol (how much the stock has been moving of late) is just off of 52 week lows which was the result of the consolidation I mentioned earlier since late April:

AMZN 1yr chart of 30 day at the money implied vol (blue) vs 30 day realized vol from Bloomberg
AMZN 1yr chart of 30 day at the money implied vol (blue) vs 30 day realized vol from Bloomberg

My View:  Something has to give here when you consider a stock like WMT is down 20% from the all time high it made back in February, and investors are piling into stocks like AMZN at all time highs on nosebleed valuations.  The headwinds that have adversely affected WMT should also weigh on AMZN. On a percentage basis AMZN has greater international exposure with more than 55% of their sales coming from outside the U.S. vs WMT at just 39%.  I have been wrong on AMZN before as to merely focus on valuation makes little sense. Investors just don’t care. But let me tell you one other thing about not caring. If history tells us anything Jeff Bezos will spend on what he wants to spend while suppressing profits as he sees fits. And why shouldn’t he? The stock is at all time highs and he is being rewarded for reinvesting in the business.

I am a little gun shy in attempting to fade the enthusiasm (see NFLX from last week.) The stock has clearly separated itself from reality once again, and that’s not the company’s fault, that’s on investors. But just because that’s the way it is, doesn’t mean that I have to agree.

But if you do have a strong sense of how the stock will react coming out of the event, or you are long the stock and fear a gap lower, here are some defined risk ways to use options around the event:  


Hypothetical Trades vs Stock at $480:

Bullish / Stock Alternative:

Buy the Sept 475/575/675 call fly for 23.00

Rationale – Not a ton of great options for replacing stock but this 100 wide call fly effectively caps your loss potential at less than 5%. This is for those that want to participate in a parabolic move higher for the next 100 dollars (sure why not) or so but fear that kind of move is also possible to the downside. This trade breaks even at 498 so its within the implied move, so any gap to 500 or higher and you’re in business like you owned stock. The downside to this trade is if the stock goes nowhere on earnings (because of that higher breakeven vs where the stock currently is.) The other downside is if the gap came on the event itself well above 500 you’d have to wait around for a month or so to truly get the fly closer to 100 deltas and therefore collect in the profits of the move.


Bearish (no prior position):

Buy the July 24th (weekly) 470/440/410 put fly for 7.00

Rationale – This targets the 440 support level for a pullback in shares while risking as little as possible by using the fly structure. The problem with this trade is that a massive down move towards 400 would mean a potential loss on the position while having been correct on direction. But with vol pumped there’s not a ton of ways to play for a move lower without risking a ton of premium.



Buy the August 450/550 collar for 7.50

Rationale – Again, not a ton of ways to protect without spending alot but this collar offsets most of the premium risk by selling an upside call at a level you should be fine with selling your stock (550 is good right?). The downside of course is giving up stock at 550 but that’s nearly 15% higher in one of the biggest market caps in the Nasdaq. (Don’t be greedy.) You have unlimited  protection against a disaster.


Fade the Implied Move:

Buy the July 24th 500/475/450 put fly for 3.50

Rationale – Not for the faint of heart as the chances of the stock barely moving aren’t great (have you seen the chart?) but if it did happen the reward is significant with implied vol so high, risking 3.50 to make 22.50. This is a lotto ticket, obviously.


2Q GAAP EPS -14 (range -61c to +37c)
2Q rev. $22.4b (range $21.85b to $22.86b) vs forecast on April 23 $20.6b to $22.8b
2Q oper. profit est. $30.97m (range -$354m to +$257m) vs forecast on April 23 -$500m to +$50m
3Q EPS GAAP est. -63c (range -$1.32 to -10c)
3Q rev. est. $23.89b (range $22.98b to $24.71b)

Key factors to watch for from RBC’s Mark Mahaney who rates the stock a Buy with a $500 Price Target:

1)GM trends– Consistent Y/Y GM expansion the past 2+ years has been one of the most important fundamental factors for stock performance. In our view, the trend needs to continue for shares to move higher and we believe it will. Expecting Q2 GMs of 33.4%, +270bps Y/Y;

2)Operating margin trends– Believe investments in China, India, etc. and in a range of projects (AWS, video, etc.) will weigh on profitability. Expecting 2.3% CSOI margins in Q2, +20 bps Y/Y;

3)AWS Momentum– AWS is a 50/50 business, growing ~50% Y/Y with ~50% EBITDA margins and a material contributor. AWS represented 7% of revenues in Q1 but ~40% of operating income. Importantly, AWS is lapping meaningful price cuts (went into effect Q2:14), which should allow for meaningful growth/margin expansion in Q2, 2H15.

And then for a look into how Mahaney arrives at his price target, and values their businesses:

Amazon Valuation We argue that Amazon is currently the sum of three segments at different business model stages, which we now have greater visibility into with the new AWS disclosure. We believe a sum-of-the-parts (SOP) approach is most relevant to valuing AMZN. We arrive at $157 per share for the North America segment by using a 30x P/E multiple on our Pro Forma segment EPS of $5.22.

We arrived at this EPS by applying a 5% Operating Margin and 33% tax rate to our $73.8B 2016 revenue estimate. Our target multiple is appropriate, we believe, given our 2014-2017 operating profit CAGR estimate of 54% and comparable multiples of leading consumer franchises.

We arrive at $81 per share for the International segment by using a 1.0x P/S multiple on our 2016 International Revenue of $38.8B. Our target multiple is appropriate, we believe, given our 2014-2017 International segment revenue CAGR estimate of 15%. It’s also the implied P/S multiple of our North America segment.

And we arrive at $209 per share for the Amazon Web Services segment by using a 20x EV/EBITDA multiple on our 2016 AWS EBITDA estimate of $5.0B. We arrived at this EBITDA by applying a 50% EBITDA Margin to our $10.0B AWS revenue estimate. Our target multiple is appropriate, we believe, given our 2014-2017 AWS segment Revenue & EBITDA CAGR estimate of 41%.

Our $500 rounded price target is the sum of these three segments, adjusting for the approximately $25.5B ($54 per share) in cash we have estimated for Amazon for year-end 2015.