Name That Trade(s) $AMZN: Earnings…or Lack There Of?

by Dan October 22, 2015 1:09 pm • Commentary

Event: Amazon (AMZN) reports Q3 results tonight after the close. The options market is implying about 9% one day move tomorrow, which is inline with its 10 year average one day move of 9%, and below the 4 qtr average of 11.5%.  I would add that on the last three earnings reports (where the stock rallied 10% on July 24th, 14% on April 23th and 14% Jan 29th) the implied move had been walking up as the stock went higher (was 7.5% prior to Jan report, 8.5% prior to April report and 10% prior to the most recent report in July). This tells me that investors have become increasingly concerned with protecting gains as the stock has moved higher. Which also tells me that the implied move is not likely to come in too much between now and earnings.  

Price Action / Technicals: AMZN is up 83% in 2015, and just 2% from the all time high the stock made on July 24th following its last earnings report.

The two year chart below shows the stock’s triple bottom from the $300 level early this year, and the subsequent three earnings gaps that has created an epic uptrend.,  If you exclude the July gap and reversal from the 24th following Q2 results, the stock is right in the channel, above recent support at $550:

[caption id="attachment_57887" align="aligncenter" width="600"]AMZN 2 year chart from Bloomberg AMZN 2 year chart from Bloomberg[/caption]

Just as was the case in April and July prior to results, the stock has NO overhead resistance, it is in UNCHARTED territory.

Fundy’s: I am going to avoid my usual rundown of fundamentals, valuation etc.  They really don’t matter with this stock.  What appears to matter most to investors is that the company continues to show their ability to be profitable, and that appears to be purely up to them.

RBC internet analyst Mark Mahaney who rates AMZN a buy with a $705 price target suggested in a note to clients that Gross Margin trends will drive stock performance:

Gross margin expansion was an important P&L trend for the stock throughout 2012, 2013, and 2014. Quarterly Y/Y gross profit growth has exceeded revenue growth by an average of nearly 12-pts since the beginning of 2012, as gross margin has benefitted from economies of scale, a revenue mix shift to all-margin Amazon Web Services (AWS), advertising revenue, and continued mix-shift to third-party retail sales.

Amazon Gross Margin expanded 390 bps Y/Y to 34.6% in Q2 – arguably the company’s highest second quarter gross margin ever. June quarter gross margin expansion benefited from the usual culprits: economies of scale and revenue mix shift to higher-margin Amazon Web Services (AWS) and third-party sales. We also note that the revenue mix shift to higher margin AWS was more pronounced in Q2 as the company lapped significant industry price cuts that went into effect during Q2:14. Third party unit sales increased to a record-high 45% of total unit sales in Q2, up from 44% in Q1 and 40% in Q2:14. We are looking for Q3 gross margin of 33.0%, implying 330 bps of Y/Y margin expansion.

How to play: Regular readers know that this stock is on my “banned list” as I am far too skeptical to get on board a story like this, its just not my cup of tea.

But For those looking to play for another breakout to new all time highs in line with the implied move:

Bullish: AMZN ($566) Buy to open Nov 575/ 625 call spread for $17

Break-Even on Nov Expiration:

Profits: of up to $33 between $592 and 625, with max gain of $33 above 625

Losses: up to $17 between $575 and $592, with max loss of $17 below $575

Rationale: if the stock goes down you lose 3% of the stock price.  If the stock goes up in line with the average over the last 3 qtrs then you can make 2x what you risked. THIS IS NOT A GREAT RISK / REWARD, but few ways to play a stock like this directionally into an event like this.

Or, play for a 10% pullback similar to what we saw in NFLX last week:

Bearish: AMZN ($566) Buy to open Oct 23rd weekly 550 / 500 / 450 put fly for $12

Break-Even on Tomorrow’s close:

Profits: of up to $38 between $538 and $462, with max gain of $38 at $500

Losses: up to $12 between $538 and $550 & between $450 and $462, with max loss of $12 above $550 and below $450

Rationale: This trade risks 2% of the stock price to define a very wide range to the downside where you could make up to 3x your money in one trading day with a break-even down 5%.  I like this risk reward, especially if I had conviction that the stock would sell off on no matter what they reported.